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Saturday, June 24, 2017 | MANILA, PHILIPPINES
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   banking report
Date posted: Monday, May 29, 2017 | Manila, Philippines

1st Quarter Banking Report (2017)

Has Bangko Sentral slayed the inflation dragon?

THE PHILIPPINES’ emergence as ‘Asia’s Rising Star’ is testament to the important role the Bangko Sentral ng Pilipinas (BSP) has played in shedding the country’s image as the region’s ‘sick man.’

In the last 12 years, average growth has been above-trend, or higher than the country’s long-run average of about 5%. The Philippines’ gross domestic product (GDP) grew even during the Global Financial Crisis, and accelerated thereafter. To date, the economy has logged 73 straight quarters of growth since emerging from the Asian Financial Crisis of 1997-1998.

Despite this uninterrupted expansion, inflation has remained low and stable, averaging 4.1% over the last 12 years alone, and dipping to its lowest monthly average on record in the last two years.

This confluence of rapid economic growth, on the one hand, and low and stable inflation, on the other, has given rise to talk that the Philippines has entered a ‘new normal,’ suggesting that the country’s abnormal growth spurts in the past are no longer transitory, but sustainable.

This new normal is also characterized by the absence of balance of payments (BOP) difficulties since 2006, around which time the Philippines emerged from International Monetary Fund (IMF) tutelage by prepaying all of its debt to the world’s lender of last resort. The country, through the IMF, even lent money to help shore up the finances of troubled EU sovereigns in the wake of the Global Financial Crisis.

As the Philippines’ central monetary authority, the BSP by law is tasked with establishing price stability, thereby helping create the conditions for balanced and sustainable economic growth. The central bank also is mandated with ensuring monetary stability and the convertibility of the peso.

In managing the country’s monetary policy, the BSP sets the benchmark interest rates, which then influences the level of demand for goods and services, and ultimately prices. Monetary policy also helps temper the inflationary effects of volatility in the exchange rate, which however comes at a financial cost to the BSP.

Starting 2002, this mandate was firmed up when the BSP adopted an inflation-targeting approach to monetary policy. Prior to this, the BSP had a monetary-targeting approach in place, whereby it aims for an optimal level of money supply, the assumption being that a correct level would help meet economic growth and inflation objectives.

Under inflation targeting, the central bank makes inflation the primary goal, announcing a target range in advance and pursuing monetary policy with a view to keeping inflation within that range.

Deteriorated peso, high prices
Before Amando M. Tetangco, Jr. took over as BSP governor in 2005, GDP growth had averaged 4% after the Asian crisis. In 2004, expansion peaked at 6.7%, the fastest since the 6.8% of 1988.

Prices however had soared by 5.5%, beyond the central bank’s 4%-5% target band due to supply-side shocks. Global oil prices went 20% higher, causing a surge in transport costs and utility charges. Weather disturbances also led to lower production of corn, exerting upward pressure on prices.

Also contributing to higher prices was the peso’s depreciation by an annual 3.28% to P56.04 on average in 2004 amid demand for US dollars in the corporate sector. Add to this, concern about the country’s fiscal balance fueled fears of higher inflation and interest rates, which caused the peso to weaken further.

“We had a good relationship with Gov. Tetangco and his officers during our stint at the Department of Finance (DoF). In fact, when I joined the Cabinet in mid-2005, we had quite a dilemma then because we started with a very deteriorated peso,” said Margarito B. Teves, who was finance secretary at the time.

“It took a combination of prudent monetary policy on the part of the BSP and the [DoF] helping out on the fiscal side by reducing the deficit to arrive at a much stronger peso,” he said.

By then, the government was pursuing in earnest a fiscal liability management program, a three-fold approach to reducing the country’s debt burden: retire foreign-currency debt and shift to peso borrowing, refinance existing liabilities by borrowing at the prevailing low rates, and lengthen the maturity of debt by paying off short-term liabilities.

By 2004, the Philippines’ budget deficit went down to 3.8% of GDP, lower than the government ceiling of 4.2%, thanks to higher tax revenue collection in the previous year.

Also making it possible for government to implement its liability management program were strong dollar inflows, courtesy of overseas Filipino worker (OFW) remittances and a growing business process outsourcing (BPO) industry -- both of which helped keep the country’s BOP in surplus.

SUPPLY SHOCKS
Mr. Tetangco presided over the shift to inflation-targeting by the BSP, which earned its inflation-targeting credentials under his leadership.

The adoption of inflation-targeting wasn’t easy for the central bank, which well into Mr. Tetangco’s first term had missed its target range by wide margins. In the first two years, actual inflation fell below the target range, amid soft patches in the domestic economy.

Through the next three years, prices increased faster than anticipated on the back of supply shocks, primarily higher international oil prices. Fueling the increase were the military conflict in Iraq as well as the production cutbacks in the US as a result of hurricane Katrina.



Closer to home, typhoons disrupted food supply, while a regional Avian flu caused meat prices to shoot up. Costlier fuel translated to fare hikes, which along with food inflation, triggered demands for higher wages.

The government’s efforts to grapple with its budget deficit likewise contributed to the upward price pressures. Congress had passed a law removing exemptions from the value-added tax (VAT).

It was only in 2007 when the BSP hit its target inflation, with the headline number staying within the announced band. But this was largely due to base effects, as the impact of the higher VAT receded. Add to this a stronger peso, which tempered the high cost of international oil.

That year’s on-target inflation, however proved fleeting, as global oil prices remain elevated even as international food prices shot up in 2008, with the government partly to blame for the latter after it drove up the price of rice worldwide. Full-year inflation averaged 8.3%, or about double BSP target of 4% (plus or minus 1%).

By 2009, price pressures abated, as the Global Financial Crisis pushed the world economy to the precipice. The Philippines’ headline inflation stayed within the BSP’s target path for the first time since adopting the inflation-targeting approach in 2002.

The succeeding five years saw inflation also staying with the BSP’s target band. This coincided with the Philippine economy’s above-trend growth spurt, excluding 2011 when government underspending led to a pullback in GDP.

In the last two years, inflation again fell below the target band, as international oil prices swooned on the back of overproduction and weak demand from major consuming countries.

Episodic factors aside, the Philippines’ low and stable inflation in recent years is also the result of tariff reforms, which accelerated in the mid-1990s. Despite a pullback in the aftermath of the Asian Financial Crisis, amid a popular outcry from the agriculture and manufacturing sectors, trade liberalization proceeded thereafter.

FOREIGN EXCHANGE INFLOWS
Freeing up the trade account was complemented by the BSP’s efforts to liberalize the capital account as well. The surge of capital inflows, especially portfolio money after the Global Financial Crisis, led to successive moves to liberalize the foreign exchange market.

This liberalization coincided with the sustained increase in inflows brought about by OFW remittances and BPO receipts. The mid-2000s onwards therefore witnessed the banishment of BOP deficits from macroeconomic discussion.

Inflows in the form of remittances play a huge part in the economy, as OFWs send money home even amid crises in countries where they work, and especially if crises struck back home. From $8.55 billion in 2004, money sent by OFWs rose to $26.9 billion last year, a threefold increase in a span of 12 years.

If remittances and BPO receipts didn’t represent ample liquidity from a BOP standpoint, then the Global Financial Crisis made sure the Philippines now had a “happy problem.” After the global economy sputtered, central banks in advanced economies slashed interest rates to almost zero, sending liquidity to emerging market economies like the Philippines.

The Philippines had to deal with plenty of money coming in, with the BSP having to step in to temper sudden fluctuations to the local currency which might affect prices of goods.

“Dollars flowing into the economy tends to appreciate the peso, and an appreciating peso always has the effect of dampening the inflation,” said Raul V. Fabella, professor at the UP School of Economics (UPSE).

Whether as an act to defend peso competitiveness or a way of insuring future demand for liquidity, in four years’ time, the BSP was able to double the country’s gross international reserves (GIR) after the Global Financial Crisis.



The GIR is used in foreign exchange operations by the BSP and as payments for imports and settlement of national government obligations. With availability of payment equalling to up to 12 months’ worth of imports in 2012 to 2014, or around nine times the country’s short-term external debt, confidence in the economy grew.

A robust external payments position, coupled with containment of the government’s fiscal excesses and robust economic growth, the Philippine scored its first investment-grade rating from global debt watchers Fitch Ratings, Moody’s and Standard and Poor’s.

COST TO BSP
According to former Bankers Association of the Philippines (BAP) President Aurelio R. Montinola III, sound fiscal policies helped the BSP strengthen the country’s external payments position.

“The amount of savings from good fiscal policy plus the interest rates coming down really gave the Philippines the fiscal space to do many things, [and in turn] helped generate foreign exchange reserves,” he said.

In 2008, the domestic to foreign borrowings ratio was 70:30. Later on, the government reduced the share of dollar-denominated securities in favor of local sources to lessen risks from currency fluctuations. Beginning 2013, the share of domestic funding to annual borrowings was at least 80%.

The Bureau of the Treasury had also conducted debt swaps as it lengthened the average maturity date of the bonds it offered amid a period of rising yields for shorter-dated debts due to the tightening of monetary conditions globally.

However, the central bank’s dollar-buying eventually manifested in its balance sheet as an expense with BSP’s surplus reserves beginning to erode in 2009.

This prompted the government to finally complete its mandated capital of P50 billion, which in 2010 was still at P10 billion -- the same amount when the BSP was created under the New Central Bank Act or Republic Act (RA) 7653 in 1993. In the succeeding years, the government injected the rightful capital to BSP’s coffers: P10 billion in 2011, P20 billion in 2012, and P10 billion in 2014.

The decrease in surplus reserves went on as the central bank’s balance sheet recorded a deficit of P380 million in 2013. By end-2015, the deficit was already P8.83 billion.

When the peso began to weaken last year, the BSP was able to recover to a surplus which was then P8.36 billion by end-December.

Due to ample liquidity in the system, the BSP later introduced the interest rate corridor that will guide money market rates, thus allowing the BSP to better manage money supply.

It also began restricting trust and non-resident funds from the special deposit account (SDA) facility as interest payment for these investors would be an added cost to BSP, at the same time boosting its effectiveness as a liquidity management tool.

RIGHT TIMING
After the Global Financial Crisis, monetary policy took the center stage, said Bank of the Philippine Islands (BPI) President and Chief Executive Officer of Cezar P. Consing. But soon enough, central banks around the world ran out of monetary policy ammunition, bringing interest rates to negative territory.

“The real question on the part of monetary policy makers was ‘How much more could monetary policy do? How much lower could you reduce interest rates to keep these things afloat?’ And that’s when you saw the use of macroprudential measures,” Mr. Consing said.

Monetary Board member Felipe M. Medalla said the timing was right for the introduction of higher capital standards in line with Basel 3, as more liquidity was released into the system.

“That was also the time when BSP was reducing the SDA levels, therefore increasing the money base. Although we were quite confident we will meet the inflation targets, we were not sure about financial stability,” Mr. Medalla said.

This brings us back to the role that transparency and accountability play under the inflation-targeting approach.

“Part of the mandate of inflation-targeting is clear communication of what the central bank intends to do. That communication came largely with Tetangco,” said UPSE’s Mr. Fabella.

“There is greater transparency and openness. The general public and the private sector does not expect too many surprises from the central bank. That is something that has gone very far in respect to BSP policies under Tetangco.”

LEGACY
It is no surprise then that financial market players were lobbying for the appointment of a BSP insider to sustain the initiatives of the outgoing central bank governor.

“Central banking is managing the country’s monetary policy and ensuring it will support economic growth,” said Mr. Teves, who after his stint as finance secretary, has returned to the private sector.

“The BSP, under ‘Say’ Tetangco, was successful in meeting its mandate of keeping inflation manageable, providing stability to the financial system, and improving financial inclusion. BSP’s success could be attributed to Say’s managerial talent, leadership skills, and teamwork. He also communicated very well, and rather frequently, with the media and other stakeholders.”

Former BSP Gov. Jose L. Cuisia, Jr., could only agree: “It was during the two terms of Tetangco that we saw the banking system at its finest, at its strongest. We’ve seen very prudent monetary policies adopted.”

And a healthy banking system is a condition for a robust economy. -- with a report from Jochebed B. Gonzales

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