»A Mid-year Economic Review

BSP keeps a firm grip on monetary policy


Central Bank – an underappreciated growth driver, financial stabilizer


Last of three parts
businessA consistent strength of the government over the last four years—one that provides stability to the financial system and is largely responsible for the recent string of sovereign credit ratings upgrades—has been the sober management of the country’s monetary policy by the Bangko Sentral ng Pilipinas (BSP) under the direction of Governor Amando Tetangco Jr.

For the average consumer, monetary policy is a murky and frighteningly complex part of the country’s governance; most people understand that it affects the prices of goods and services, and for the vast number of Filipinos who have a family member working abroad, it affects the exchange rate between the dollars, euros, and pounds OFWs send home, and the pesos that are spent here.

Monetary policy is obviously more comprehensive than that, and in assessing the performance of the BSP and looking forward to what direction fiscal management might take for the rest of the year, there is a risk of oversimplifying things.

Thus, in order to make this third installment of The Manila Times’ Mid-year Economic Review relevant to a general audience, it will focus on three key areas that have provided a solid foundation for positive perceptions of the Philippine economy: Management of the country’s money supply, which has a direct impact on price inflation and exchange rates; management of gross international reserves (i.e., foreign currency and other assets), which affect the country’s ability to sustain debts as well as having an impact on the money supply; and regulation of the banking industry, which determines the health of the financial system.

Money supply: Too much of a good thing
The broadest common measure of a country’s money supply in valuation terms is called M3, which includes cash and readily-convertible assets, such as checking deposits, “near money,” which are assets that are less convertible but still can be turned into liquid assets fairly quickly, such as savings deposits, and assets such as large time deposits, institutional money market funds, and short-term repurchase agreements.

The BSP tracks other money definitions as well (M1 and M4), but publishes the M3 measure as a matter of routine and primarily relies on it for policy decisions.

One of the biggest challenges the BSP has faced in the past few years was the expansion of the money supply, which is one indicator, albeit not an entirely trouble-free one, of a robust economy.

At the end of 2010, according to BSP data, M3 stood at P4.48 trillion, which represented a year-on-year increase of 10 percent. M3 grew by 7.1 and 9.4 percent in 2011 and 2012, respectively.  But in 2013—in part and not entirely due to the build-up of “hot money” from the US Fed’s Quantitative   Easing (QE) program – M3 growth soared by 31.8 percent year-on-year, reaching P6.93 trillion. As of end-May 2014 growth had cooled somewhat due to BSP intervention, and stood at P6.94 trillion. This figure, however, still represented a 28.4 percent increase from the same month a year earlier.

Excessive domestic liquidity can lead to price inflation, the unsupportable expansion of credit, and equity price bubbles, so the management objective of the BSP is to “soak up” excess money from the financial system.

BPI Associate Economist Nicholas Antonio T. Mapa gives the BSP high marks for its management of inflation through the regulation of liquidity.

“I think the BSP has done a great job in enacting its price stability mandate in the past few years,” Mapa said. “In the first half of the year, they’ve acted three times to siphon off liquidity in the market to safeguard against inflationary pressures.”

Managing liquidity in a growing economy is challenging under any circumstances.

What has added a degree of extra complication to this task for the BSP is the large influx of foreign currency, which had the additional effect of putting upward pressure on the value of the peso.

Soaring GIR
One of the main reasons any central bank seeks to maintain an adequate amount of international reserves is as a tool to manage the value of the country’s domestic currency.

Gross international reserves (GIR) consist of actual foreign currency holdings, foreign investments (usually in the form of bonds), special drawing rights (SDR) through the International Monetary Fund (IMF), gold reserves, and the country’s reserve position in the IMF, which is the claim the country can make on the IMF’s general resources account. GIR is usually valued in US dollars (even though the value fluctuates on a daily basis) and the number of months the reserves could pay for imports, services, and income.

At the end of 2010, the Philippines’ GIR stood at $62.37 billion, the equivalent of 10.4 months’ worth of imports and other expenses. By the end of 2013, GIR had ballooned to $83.19 billion (11.5 months), which was actually slightly lower than its high for that year; in March 2013, GIR was $83.95 billion, the highest it has ever been. As of the end of June 2014, GIR totaled $80.73 billion, the equivalent of 11 months’ imports and expenses.

In general, high GIR is a benefit to the country; for one thing, it serves as ready collateral for sovereign debt, and in the Philippines’ case, was a significant factor in sovereign credit ratings upgrades that finally pushed the country into investment-grade territory. But it can also be problematic, and in the BSP’s case, is one area where the central bank has encountered some controversy.

GIR can tie up the central bank’s ready capital, particularly if foreign currency purchases are used to control an overheating local currency, which appears to have been the case through 2012 and most of 2013, when the foreign exchange component of the GIR skyrocketed from $423.5 million to more than $1.5 billion.

That period corresponds to a rapid appreciation of the peso against the US dollar (from P43.82:$1 at the beginning of 2012 to P40.42:$1 at the end of January 2013), a rapid depreciation between February and September 2013 as the peso fell to P44.39:$1, and then another short-term appreciation through October back to P43:$1.

Also during that period, the BSP received P40 billion in fresh capitalization from the government—money the BSP was legally entitled to, but had not received, according to the terms of the New Central Bank Act of 1993, three-fourths of which was provided through the controversial Disbursement Acceleration Program (DAP).

The circumstantial evidence is that a great deal of the BSP’s capital, including some or all of the P40 billion in additional capitalization arranged by the Aquino Administration, was applied to foreign currency purchases to keep the peso from over-appreciating in value. The reason was actually reported in precisely those terms by at least one of the major television networks and some newspapers in March 2013, when the BSP proposed increasing the recapitalization by P150 billion—in an effort that ultimately did not succeed due to other factors driving the peso’s value.

This has led some observers to critically question the BSP’s management of GIR and currency rates, questions to which the central bank has subtly responded by ‘letting some of the air out of the balloon,’ reducing the foreign exchange component of GIR through foreign debt repayments. (Note: The larger issues of the peso exchange rate will be discussed in greater detail in an upcoming special report.)

Iron-fisted prudential management
Since President Aquino’s inauguration at the end of June 2010, the BSP has closed 94 banks in the Philippines, most of them rural banks, but including several larger savings banks—most notably, the controversy-ridden Banco Filipino, which had 62 branch offices—and one commercial bank, Export and Industry Bank, the first commercial bank failure since Urban Bank in 2000. Ironically, Export and Industry had acquired Urban Bank’s remains in 2001, leading some analysts to offer the tongue-in-cheek observation that it might have acquired a curse as well.While some of the closures of failing banks have been met with sharp criticism—the Banco Filipino case was particularly contentious, and was eventually decided in the courts—the BSP has stuck to its guns in making soundness of the country’s banking system a top priority.

Recent moves by the central bank to curb credit have been particularly directed at the hyperactive real estate lending sector, and have included new limits to banks’ exposure to real estate loans, and just this month, implementation of a new “stress test” for banks to verify their ability to absorb bad loans.

The BSP has, at least until yesterday’s benchmark interest rate hike, also shown a preference for combining prudential management with its inflation-targeting program, raising banks’ reserve requirement ratio (RRR) twice this year, bringing the rate up to 20 percent—and the interest rate on Special Deposit Accounts once as a means of checking inflation by reducing money supply, and pushing banks to a somewhat more conservative asset position.

ING Bank Manila Senior Economist Joey Cuyegkeng shed some light on the BSP’s overall approach to manage distinctly different but intricately interconnected objectives.

“The BSP’s monetary policymaking is largely risk-based—addressing quickly emerging risks to avoid major and disruptive adjustments. Managing inflation remains a main focus,” Cuyegkeng explained.

As an example, Cuyegkeng points out that, “Concerns over the property sector emerged a couple of years ago, but BSP has started to manage possible risks of a property bubble though macroprudential measures. The latest is the directive to banks to conduct a real estate stress test (REST).”

Cuyegkeng also sees forward thinking in the central bank’s approach to managing inflation. “Inflation risks have emerged recently and BSP preemptively started to address this, initially to mop up liquidity through RRR hikes and lately by raising SDA rates,” Cuyegkeng said.

Independence key to bank’s effectiveness
The overall success of the BSP during Aquino’s term puts the Administration in a somewhat dubious position: Much of the reputational capital the Philippine economy has earned during that time is not creditable to Malacañang, but a distinctly independent institution whose current approach and outlook was entirely developed during the latter half of the Arroyo Administration.

Tetangco, a 30-year veteran of the BSP, was first appointed to his current post in 2005.

Making Aquino look good has not been without its challenges, either. While many of the potential problems the BSP must overcome in maintaining currency value, inflation rates, and the health of national accounts, are certainly due to external factors, some of Aquino’s policies—such as recent decisions increasing the import volume of rice from the 800,000 MT planned at the beginning of the year to potentially 1.8 million MT by years-end—have worked at cross-purposes to an institution that has actually become his biggest ally.

BPI’s Mapa agreed that the BSP has been critical to the economic progress claimed by the President.

“I would credit them with the strong growth over the past four years of this administration, more than any government agency,” Mapa said. “Their provision of a low and stable inflation environment, coupled with accommodative monetary policy all enable the Philippines to post its stellar growth print given the country’s reliance on personal consumption expenditure.”

Whether the BSP will be able to maintain the relatively good current economic conditions remains an open question. Inflation, already much higher than anticipated and near the upper limit of the BSP’s target range, is a worrisome threat, as are growing global crises such as conflicts across the Middle East and in Libya, increasing animosity between Western powers and Russia over the insurgency in the Ukraine, and West Africa’s uncontrollable Ebola epidemic that could not only drive inflation in spite of BSP actions to control it, but also significantly impact global markets beyond the uncertainty they have already created.

Analysts’ views, however, suggest the BSP’s record so far warrants a positive outlook on the central bank’s ability to adapt to a changing economic environment.

“They have moved pro-actively by unveiling several macroprudential measures to complement their policy tools,” BPI’s Mapa explained, “and they have been actively monitoring the financial system, as well as the real estate sector, given its ability to affect the country’s banks through risk exposure.”

ING’s Joey Cuyegkeng was similarly complimentary of the BSP’s efforts, but suggested that the central bank could also use some help. “To enhance further BSP’s ability to respond to the challenges of the times, amendments to the BSP charter would be necessary,” Cuyegkeng said. “These changes would include an increase in its capitalization and protecting BSP executives as they conduct supervisory functions over the banking system.”


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