YEARENDER: Monetary authorities keep lid on rates, inflation amid turmoil in global markets

MANILA, Philippines - The Philippines managed to stave off the impact of the turmoil in the global financial markets brought about by uncertainties caused by the interest rate increase in the US and the economic slump in China, with the Bangko Sentral ng Pilipinas (BSP) keeping interest rates steady for the entire 2015.

BSP Gov. Amando Tetangco Jr. said robust domestic demand and benign inflation allowed monetary authorities to keep rates unchanged for 10 straight policy-setting meetings since October last year.

Tetangco said the Monetary Board’s decision to keep rates steady last Dec. 17 was based on its assessment of inflation dynamics and the risks to the inflation outlook over the policy horizon. 

The BSP raised interest rates by 50 basis points in 2014, bringing the overnight borrowing rate to four percent and the overnight lending rate to six percent as well as the reserve requirements for banks to 20 percent to siphon off excess liquidity in the financial system.

Inflation averaged 1.4 percent in the first 11 months of 2015 after kicking up to 1.1 percent in November from the record low 0.4 percent in October due to a spike in food prices.

Inflation is expected to range between 1.1 and 1.9 percent in December due to an increase in LPG prices, upward electricity rate adjustment, transitory increase in food prices due to Typhoon Nona and the weaker peso.

The BSP has further retained its inflation forecast to 1.4 percent as the rise in consumer prices bottomed out in October at 0.4 percent due softening of oil prices as well as other food prices.

However, monetary authorities adjusted its inflation forecasts to 2.4 percent instead of 2.3 percent for 2016 and to 3.2 percent instead of 2.9 percent for 2017 due to the higher inflation in November, the impact of the weakening pesos against the dollar, and the increasing price of key commodities due to weather disturbances.

“Inflation is seen to return gradually to a path consistent with the inflation target for 2016-2017, as the effects of recent weather disturbances continue to be felt. Meanwhile, inflation expectations remain firmly anchored within the inflation target band for 2016 and 2017,” Tetangco said. 

Tetangco said potential upside pressures could come from the impact of prolonged El Niño dry weather conditions on food prices and utility rates as well as pending petitions for power rate adjustments, while downside risks could arise from possible slower-than-expected global economic activity.

Furthermore, he added the BSP also observed domestic demand conditions are likely to stay firm, supported by solid private household and capital spending, buoyant market sentiment, and adequate domestic liquidity.

The growth in the country’s gross domestic product (GDP) accelerated to six percent in the third quarter of 2015 from the revised 5.8 percent in the second quarter amid robust domestic demand and improving government spending.

The growth in GDP averaged 5.6 percent in the first nine months of 2015, way below the seven percent to eight percent target penned by economic managers.

The country’s  GDP has been growing for 67 straight quarters. The economy contracted by 3.1 percent in the fourth quarter of 1998 due to the Asian financial crisis.

Last Dec. 17, the US Federal Reserve raised its near zero interest rates by 25 basis points for the first time in nearly a decade finally ending uncertainties brought about by the impending interest rate lift off.

“The Monetary Board has considered the potential impact of the recent monetary policy adjustment in the US on global financial conditions, noting that keeping monetary policy settings steady at this juncture would allow the BSP some room to continue to assess evolving global economic conditions and calibrate its policy tools as appropriate,” Tetangco said.

He pointed out monetary authorities would continue to monitor domestic and external developments to ensure the monetary policy stance remains in line with price and financial stability.

What credit rating agencies say

After receiving a series of credit rating upgrades in 2014, the Philippines got a single positive action from three international rating agencies this year.

Fitch Ratings raised the country’s outlook to positive from stable on the back of its strong macroeconomic fundamentals as well as the improved government standards and competitiveness indicators under the Aquino administration.

Fitch upgraded the country’s outlook to positive from stable last September as it affirmed the credit rating at ‘BBB-” or minimum investment grade.

Tetangco said the positive outlook from Fitch signals the long overdue rating upgrade to reflect the economy’s outperformance that would help it withstand risks posed by the global economy.

 “Sharp market volatility witnessed recently across the globe posed threats of spillover effects on the real sector of economies. What makes the Philippines an outperformer are its strong fundamentals, which entice short- and long-term capital once markets see through the temporary noise,” Tetangco said.

With the upgrade, Fitch could raise the country’s sovereign credit rating over the next 18 months especially if the improvement in governance standards over the Aquino administration would be sustained.

Moody’s Investors Service as well as Standard & Poor’s both retained the country’s credit rating that were upgraded to a notch above minimum investment grade in 2014.

Moody’s awarded a Baa2 with a stable outlook to the Philippines in December 2014 while S&P gave the country a BBB with a stable in outlook in May 2014.

Robust external payments position

BSP Deputy Governor Diwa Guinigundo said the country’s robust external payments position has given the country enough buffer to survive external shocks.

The BSP has lowered the projected gross international reserves (GIR) - the sum of all foreign exchange flowing into the country - to $80.7 billion instead of $81.6 billion this year as the country’s foreign exchange buffer continued to drop.

The reserves serve as buffer to ensure the Philippines would not run out of foreign exchange that it could use to pay for imported goods and services, or maturing obligations in case of external shocks.

The country’s foreign exchange reserves declined to $80.57 billion in November from almost a two-year high of $81.09 billion due to higher foreign debt payments as well as the lower gold prices in the world market.

The central bank now expects cash remittances from Filipinos abroad growing by four percent instead of the original projection of five percent. Remittances inched up 3.7 percent to $20.64 billion in the first 10 months pf 2015 from $19.91 billion in the same period in 2014 due to the continued weakness of other currencies in major host countries against the dollar.

The central bank has lowered its projected current account (CA) surplus to $8.9 billion or three percent of GDP instead of 14.2 percent or 4.4 percent of GDP last year due to the country’s widening trade deficit. The surplus declined by 18.7 percent to $5.6 billion or 2.6 percent in the first nine months of 2015 from $6.8 billion in the same period in 2014 due to the widening trade-in-goods deficit.

Monetary authorities now expect the country’s merchandise exports contracting by four percent instead of growing by five percent while imports are expected to be flat instead of inching up by one percent in 2015.

The BSP maintained its outlook for the BOP surplus at $2 billion in 2015 from a shortfall of $2.9 billion in 2014.

It expects foreign direct investments (FDIs) inflows hitting $6 billion in 2015 and $6.3 billion in 2016 amid the country’s strong macroeconomic fundamentals and the implementation of much needed infrastructure projects under the public private partnership (PPP) scheme.

Guinigundo said strong FDI inflows particularly in PPP projects are crucial in maintaining the momentum in the country’s continued economic expansion.

 “We expect that FDIs will continue to grow. This is very important in sustaining economic momentum in the Philippines,” he said.

 On the other hand, the central bank expects a net outflow of foreign portfolio investments amounting to $1.3 billion this year from a net inflow of $200 million last year.

 “This is again something that we do expect because of the continued play in the financial markets because of the uncertainties surrounding China and other emerging markets as well as the new issue as to when is the next move of the US Fed and how much,” he said.

Foreign portfolio investments are also known as ‘hot money’ mostly invested in shares listed at the Philippine Stock Exchange (PSE) since these are speculative capital flows that move very quickly in and out of markets.

The revisions took into consideration the downward revision in the global growth outlook for this year as well as the decline in commodity prices particularly oil and metal.

Peso weakens by 5.2% in 2015

 Amid the strong outflow of foreign capital into the country, the peso continued to emerge as the least volatile currency in Asia.

The peso closed 47.06 to $1 last Dec. 29, 5.2 percent weaker than the 44.72 to $1 level in Dec. 29, 2014.

Guinigundo said the peso continued to depreciate due to global uncertainties brought about by the slowdown in the Chinese economy, the devaluation of the Chinese yuan, and the prospect of rising US interest rates.

The central bank has vowed to contain excessive volatilities in the foreign exchange market in order to “smoothen” the movement of the peso against the US dollar to help business and consumers plan more effectively. It moves in response to market forces but with scope for central bank participation in the foreign exchange market to smoothen sharp fluctuations.

Challenges ahead

Aside from uncertainties in the global financial market due to the normalization of interest rates in the US and the slowdown in China, the Philippines is also facing risks in the domestic front due to the presidential and national elections in May.

Rating agencies stressed the need to sustain the reforms undertaken by the Aquino administration.

The BSP is also expected to put in place the proposed changes in the framework for monetary operations through the interest rate corridor (IRC) designed to enhance the effectiveness of monetary policy in the second quarter. 

It expects short-term volatility due to the migration of funds from the special deposit account (SDA) facility to higher yielding term auction deposit facility under the new system.

The system calls for a shift to the use of floor and ceiling rates for short-term financing to be determined through the auction of seven and 28-day deposit maturities initially set at once a week.

The auction to be conducted by the BSP would not compete with the auction of Treasury bills and Treasury bonds being conducted by the Bureau of Treasury.

 The BSP said the IRC would help improve the transmission of policy rate adjustments to relevant money market rates, and ultimately to key macroeconomic variables.  It would strengthen the signaling effect of policy rates and provide a system that would allow easier price discovery particularly in the money markets.

The IRC framework involves the establishment of the required infrastructure to effectively implement the monetary policy stance.