ING sees BSP cutting SDA rates by 100 bps

MANILA, Philippines - Dutch financial giant ING sees the Bangko Sentral ng Pilipinas (BSP) cutting interest rate on special deposit accounts (SDAs) by another 100 basis points to further drive away hot money.

ING said the BSP move should lead to tighter liquidity, higher short-term interest rates and a weaker peso.

Since the BSP’s latest round of SDA rate cuts on March 14, the peso has depreciated by 1.6 percent against the dollar.

“This represents a sharp reversal of fortune for the peso,” Tim Condon, ING chief economist in Asia said.

The March 14 rate cut was a game-changer for signaling that the peso was subject to two-way risk. There was not enough hot money left to push up short-term interest rates, which continue to hover below 50 bps against the 2.5 percent for the SDA rate.

Condon sees the BSP moving to an interest rate corridor system wide enough that short-term interest rates is inside by cutting the SDA rate by another 100 bps.

“We expect outflows of hot money will tighten liquidity and drive short-term rates into the corridor which would re-connect market rates to the policy rate,” Condon added.

Interest rate corridor systems help the central bank maintain rates at levels consistent with its desired monetary policy stance while also curbing short-term interest rate volatility.

The ING said the BSP is moving to a corridor system in which the SDA would be converted into a borrowing facility. The reverse repurchase (RRP) facility would be defunct but the rate on the lending facility could be the current RRP rate.

Condon said there are a lot of hot money in fixed rate Treasury notes (FXTNs).

While the country’s gross international reserves have increased by $478 million to $84.1 billion in March, portfolio investment data showed a net outflow of $395 billion, the first outflow in nine months.

“The BSP’s cumulative 100 basis points of SDA rate cuts this year have discouraged new inflows and caused some of what’s already onshore to decamp, which partly explains the reduced peso-appreciation pressure,” ING said.

Further SDA rate cuts would enhance the process and push up short-term interest rates,” the ING economist added.

The recently released 2013 Article IV report of the International Monetary Fund (IMF) for the Philippines said “market rates have become disconnected from official rates” as abundant liquidity has weakened the BSP’s monetary policy transmission mechanism.

Condon said the IMF’s prescription for the BSP to “lean against the wind” in the foreign exchange market “makes the peso a one-way bet” for speculators.