• Weak peso, twin deficits to force BSP to reset policy setting – Deutsche Bank


    ‘But crude prices are a greater threat to inflation’
    A peso under pressure from a potential double-deficit in the fiscal and current account balances are prompts that the central bank could not afford to ignore against the backdrop of rising inflation and domestic demand, global lender Deutsche Bank said over the weekend.

    Thus, the Bangko Sentral ng Pilipinas (BSP) would have no choice but to adjust its policy tools, particularly benchmark interest rates, the German lender noted.

    The peso was one of emerging market-Asia’s worst performers in 2016, weighed down by investor concerns over the Philippines’ foreign policy directions under President Rodrigo Duterte, according to the Deutsche Bank.

    “Following 5-percent depreciation against the US dollar in 2016, we believe the peso would remain under pressure in 2017 on the back of US Fed rate hikes and RMB depreciation pressures, not to mention potential domestic sources of uncertainty such as politics and a new leadership at the BSP,” it said.

    In its forecast, Deutsche Bank noted the peso could slip at P49.9:$1 by the end of the first quarter of 2017, before depreciating to P51:$1 in the second quarter.

    By the end of the year, the Philippine currency could plumb the P51.7:$1 level—in line with the P50:$1 to P52:$1 forecast made by financial institutions such as UBS, BMI Research, ING Bank Manila and First Metro Investments Corp.

    However, any hard currency liabilities due within the next 12 months can still be covered by the country’s gross international reserves which remain ample at $81.04 billion as of end-December 2016, Deutsche Bank noted.

    But Philippine foreign reserves could moderate to $79.8 billion, it said. A deterioration of the current account, which could turn a deficit of $1.4 billion in 2017 as oil prices and domestic demand soar, “could prompt the BSP to tolerate a weaker peso, as of course dictated by the market.”

    Above all, Deutsche Bank said a weak peso tends to stoke inflation, which has already bottomed out before climbing at a two-year high of 2.6 percent in December.

    Citing its value-at-risk model on the peso-dollar exchange rate with crude oil prices and inflation as variables based on monthly data over the past 16 years—2000 to 2016—the bank sai d the impact of the foreign exchange rate on inflation “is not statistically significant.”

    The risk of inflation running away by 20 basis points (bps) in the first four months is great with the onset of a 10-percent peso-dollar exchange rate shock before the response eventually dies down, the German lender noted.

    The inflationary response to higher crude oil prices is more persistent and significant, raising inflation by at most 30 bps from a 10 percent price increase, it added.

    “We thus see inflation sustaining its uptrend in 2017 on the back of higher crude oil prices and a weaker peso,” it said, forecasting the inflation rate to hit 3.3 percent on average from 1.8 percent in 2016.

    “But with oil prices likely settling at $55 per barrel this year, and without the planned excise tax hike on petroleum, set to be implemented only in early 2018, we do not see inflation risking to break the 4 percent upper end of the BSP’s inflation target,” it added.

    “Admittedly, we see risk of a rate hike given relatively higher inflation, robust domestic demand and likely peso depreciation pressures,” it said.

    After lowering the overnight borrowing rate to 3 percent from 4 percent in May 2016, in the run-up to adopting an interest rate corridor system on June 3, the central bank has kept the policy rate unchanged for the rest of 2016.

    The policy-setting Monetary Board also kept the corresponding rates for overnight lending at 3.5 percent and deposit facilities at 2.5 percent. The reserve requirement ratio was also kept steady at 20 percent.


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