Singapore-based DBS Bank said it is seeing early signs of an overheating Philippine economy – making a case for a monetary policy tightening in the coming months.
“The Philippine economy is displaying early signs of overheating,” DBS said in a report, citing the factors that prompted its assessment: nearly 7 percent growth in gross domestic product (GDP) in 2016; above 3 percent headline inflation rate since February 2017; very strong investment growth; more than 20 percent expansion in gross fixed capital formation in 2016.
An economy starts to overheat when a prolonged period of growth has spurred faster inflation from increased consumer spending and supply allocations have become inefficient as manufacturers overproduced, creating excess production capacities in an attempt to capitalize on high levels of wealth, as described by Investopedia.
Philippine GDP grew 6.9 percent last year, while inflation accelerated to 3.1 percent on average in the five months to May 2017.
Investment growth, meanwhile, continues to show momentum, forecast by DBS to hit a still brisk 9.8 percent this year despite a high base in 2016.
“Hence, there is a case for the central bank to tighten monetary policy in the coming months,” DBS said, noting, “the Bangko Sentral ng Pilipinas (BSP) has, however, refrained from lifting the policy rate.”
The central bank lowered its reverse repurchase rate to 3 percent from 4 percent in May last year in the run-up to adopting an interest rate corridor system on June 3, 2016. It has since kept its key policy rate unchanged.
“While our current inflation forecasts still fall within the Bangko Sentral ng Pilipinas’ official target of 2 percent to 4 percent, we reckon that rate hikes are imminent,” DBS said.
Prompted by an accelerating inflation, driven by food and transport prices since the beginning of this year, DBS revised its inflation forecasts to 3.2 percent for 2017 and 2018, from earlier estimates of 2.8 percent this year and 3 percent for 2018.
“Transport inflation is set to rise further towards the year-end, particularly given the low base effects from 2016. Furthermore, expect second-round impact from the increased levies under the tax reform bill, even if the direct impact is likely to be modest,” the bank said.
The Comprehensive Tax Reform Program, which the House of Representatives approved last month, seeks to introduce new excise taxes for diesel, cooking gas and sugar-sweetened beverages. Higher duties will also be imposed on gasoline, kerosene, as well as automobiles.
“Coupled with upside risks to inflation, growth remains fairly robust. Indeed, given the aggressive infrastructure overhaul, there is need to manage overheating risks in the economy,” DBS noted.
“Among others, long-term growth sustainability remains as a key priority. Against this backdrop, look for a total 50 basis point rate hikes in third-quarter 2017,” it added.
The BSP may be even slightly behind the curve in normalizing its monetary policy. “We reckon that rate hikes might have been delayed due to the imminent change in the BSP leadership,” DBS said.
Incoming BSP Governor Nestor Espenilla Jr. will take over the BSP leadership on July 3. Outgoing Governor Amando Tetangco Jr. is retiring on July 2.