CROSSROADS – February 14, 2018

The Philippine Statistics Authority reports that prices in January compared to those of the same month last year, rose four percent.

While this is a moderate inflation rate, new conditions are creating inflationary pressures. Monetary authorities will face these challenges as they try to stabilize prices in a time of sustained growth effort.

Immediate inflationary pressures. Enlarged government development programs, as well as the demand of peace and order operations, will abet rising prices. The recent tax reform program (TRAIN), while initially causing an increase in prices on affected goods, fortunately will help in providing more revenues to counter the inflationary developments.

Even in this context, the fiscal deficit is expected to rise. Could that rise exceed the expected level of around two percent of GDP?

Budget pressures will come from two fronts: (1) Increased government expenditure commitments, including much larger social spending: and (2) Public infrastructure expenditure arising from Build Build Build.

The expenditures will worsen the balance of payments. Signs of this are already hinted by recent trade and payments numbers.

Moreover, recent international developments have shown continued geopolitical tensions, especially in East Asia, our immediate neighborhood.

In this context, the threat of nuclear miscalculation, or even simply, of destructive regional war is a big worry in the current international scene.

The problems of oil supplies being ripped is real in the very tense Middle East.

Moreover, the concerns about inflation in the world economy have returned after years of low interest rates because of depressed world conditions then. Economic growth has returned in the US and in Europe. The US Fed is expected to initiate a more aggressive interest rate policy stance to contain future inflation.

The potential for the peso exchange rate to be affected by all such forces interacting, therefore, cannot be discounted. The recent depreciation of the peso might, to some extent, be partly the result of all such factors playing a role. The peso exchange rate is another means by which inflation is transmitted, even as it is also a tool for restoring balance in the country’s trade and payments situation.

On the whole, these developments are a reminder that inflation fighting could be the next important macroeconomic problem.

Inflation-targeting policy. The Bangko Sentral ng Pilipinas’ main mandate is to keep monetary stability. To achieve this objective, it sets an inflation rate target for the economy and tries to keep prices within the target.

The inflation target for 2018-2019 year is three percent ± one percentage point. Thus, the inflation target is not a fixed rate of inflation target, but one within a narrow range.

So far, the rate of inflation of four percent is within this range, but note that actual inflation rate (the rise of the consumer price index) has already been reached at the ceiling target.

In fact, the year-on- year rate of inflation has been rising. In December 2017, the yearly inflation rate was 3.3 percent but back in January 2017, the yearly inflation rate was 2.7 percent. This indicates an inflationary path over time.

So far, the BSP is hopeful and confident that the current inflation target is not getting out of range. It has the instruments to manage the rate of inflation.

Fiscal and monetary policy coordination. Yet, the inflation target is not an iron-clad number. It is within the powers of the government  to make adjustments to the inflation target.

The current inflation target was adopted in 2015. In a previous period (in 2010), the inflation target was higher at four percent ± one  percentage point.

As an independent monetary authority, the  BSP will manage what it assumes to be its target, which in essence and in general, is initially set with the help and advice of the fiscal authorities (the budget and finance departments, and also the NEDA).

In fact, it is an inherent element in the coordination between the fiscal and monetary authorities to ensure that growth targets and inflation targets are made compatible.

If they should be in conflict, some adjustment might be deemed essential so as to avoid creating a trade-off between inflation and growth.

The formal venue for this coordination is the Development Budget Coordination Committee (DBCC), composed of the budget, finance, NEDA and BSP, through their respective heads.

In this committee, the principals reach an agreement regarding expenditure, economic growth, and price targets. Whereupon, the BSP issues its policy targets as agreed upon.

Tools for managing the inflation target. The central bank then implements the inflation target range. The BSP has a number of policy tools to influence the inflation rate.

Mainly, it is through adjustments that raise or reduce the interest rate on credit or deposit transactions that the central bank can control. A high interest rate tightens the money supply and credit, while a lower rate expands money and credit.

The primary tool that the central bank uses is the reverse repurchase rate, or RRP which is essentially the central bank’s borrowing rate when it borrows money from commercial banks.

In addition, other monetary tools to influence credit are: the term deposit auction rate; overnight lending and deposit rates; the reserve requirements for deposits in banks; the rediscount rate on loans; the central banks sale or purchase of government securities.

Each of these tools could have specific impact on a segment of the money supply, and all of them together operate to produce a singular impact on the level of the money supply and, hence, on the inflation rate.

Some of these measures require a major reexamination. For instance, in the past the reserve requirement had been set so high compared to what other countries in the region did. The Philippines today has the distinction of having the highest reserve requirements within ASEAN.

Governor Nestor Espenilla Jr. of the BSP wants the reserve requirement reduced to align it more reasonably with the central banks in the region.

That cannot be done immediately for such an act would abet inflation because it expands money supply. The measure has to be fine-tuned with other important policies that, on the whole, acts as a brake on inflation.