Bernardo M. Villegas
Articles  >> more topics
Battle Against Inflation (Part 1)

 In the short run, the most important economic battle that the Marcos jr.  Administration has to win is inflation.  From January to April, inflation accelerate to a high of 7.9%, compared to 3.7% a year ago. This is considerably above the forecast of the BSP of 5.5 % for the whole year.  It is twice the target for the last quarter of 2023 of below 4 %.  It is no comfort to know that all over the advanced world, inflation is also at record highs, especially in the U.S. and Europe.  In fact, Germany has already succumbed to a recession.  As the Financial Times reported last May 19, 2023, advanced countries are experiencing the most acute—and most enduring –outbreak of inflation in generation.  Unfortunately, across the world, poor forecasts have contributed to central bankers failing to do their main job:  maintaining price stability.  What are the chances that the target of our Central Bank for the last quarter will be met?

In my view, the BSP has both the necessary tools and competence to meet its target.  Looking back at the last twenty years, all episodes of higher inflation were successfully addressed by the BSP.  In 2001, inflation was at a high of 5.35%.  The next year, it was brought down to 2.7 %.  In 2006, it was 5.49% followed by 2.9% the year after.  In 2018, inflation rose to 5.31 % but was brought down to 2.39% just one year later.  As I have written very often, our Central Bank is one of the economic institutions that have benefited from the practice of every President over the last 30 years to always appoint the best and the brightest to manage the economy.  Over the last thirty years, we have seen a BSP totally ravaged at the end of martial law evolve into one of the best Central Banks in the region.  In fact, since at least the tenure of Jose Cuisia Jr. during the time of President Cory Aquino, our BSP Governors have been systematically rated the best if not the best in the region.  The most recent one to be rated as the best Central Bank Governor in the world was Benjamin Diokno. 

A most recent testimony to how well the BSP has been doing its job in managing our monetary system was given by Dr. Ragnar Gudmundsson, IMF Resident Representative to the Philippines.  In responding to questions about how the ongoing U.S. banking crisis precipitated by the collapse of some large U.S. regional banks, starting with the Silicon Valley Bank (SVB), will impact on the our banking sector, he said that the Philippine banking system is well capitalized and has liquidity buffers.  The banks’ “conservative” risk management practices and well-diversified portfolios helped them to withstand possible shocks and higher interest rates.  We can attribute these prudent practices of Philippine banks to the sound regulatory practices of the BSP.

Here, I would like to share with my readers the recent report by one of the top investment analysts in Asia, Jim Walker of Aletheia Capital, about the battle against inflation in the Philippines. I have known Jim for the last twenty years and have always valued his sharp insights into global trends.  After visiting the Philippines and talking to his many contacts in the financial and economic sectors, he came out with a glowing analysis of the prospects of the Philippine economy entitled “Philippines in Fine Form.”   As regards inflation, his advice in the short term is to address farm productivity and food importation.  Longer term, he averts, monetary conditions will decide the inflation course.  Jim has a good word for the BSP:  “It has been the most aggressive central bank in Asia when it comes to rate rises.  The Central Bank has delivered 425 points in rate rises since May 2022, in line with the Fed and 200 basis points more than its nearest challenger in the region, Bank Indonesia.” 

            Jim is not one to pull punches, though.   When criticism is due, he gives it readily.  He observed that while the BSP paused its rate hikes in the third week of May 2023,  there is still a negative gap between local interest rates and recorded inflation.  The downward trend in headline consumer prices will have to be maintained or BSP will be forced to raise rates further.  Jim opined that the current money managers led by Governor Felipe Medalla  are paying for what happened during the pandemic when then Governor Diokno cut rates to 2% even though headline inflation was running at 4%.  Even the best Governor in the world can make an understandable policy mistake.

            Jim sees the monetary conditions in the Philippines as not being accommodative at present.  He finds this very logical because our country imposed one of the severest pandemic lockdown responses (probably next only to China).  Thus, the fiscal and monetary responses to the government-mandated closure of business and society was inevitably massive.  When the fiscal position blew out, the government’s spending was financed by the BSP’s balance sheet growing 60 % from early 2020 to 2021.  It has since dropped by 10 %, largely because of intervention to try and hold the value of the peso, while interest rates caught up with those elsewhere in the region. 

            Jim accurately describes the various monetary tools that have been available to the BSP throughout the last twenty years, which it has been employing with skill and prudence.  While interest rates have risen, the BSP has effected quantitative tightening (much more than the US Federal Reserve) and reserve requirements ratio (RRR) remains elevated.  He thinks that the Philippines cannot be accused of accommodating inflation too much.  He advices though that to ensure that consumer prices do come under control, repo rate should be kept higher for longer.  If there is a desire to ease monetary conditions domestically, he thinks that the tool should be the RRR.  Reducing the ratio to 2 to 4 percentage points would bring it into the same range as its regional peers (such as Indonesia and Thailand), while cutting the banking some slack to finance investment spending.

            Jim reads the investment mood in the Philippines accurately.  Like him, I think that local businesses are “gung ho” especially in such sectors as infrastructures, large-scale agribusiness, renewable energy, economic and low-cost housing, logistics, tourism and mining.  Jim made the observation that over the last 20 years, the percentage of gross fixed capital formation in GDP has risen.  Despite the negative image that the Duterte Administration developed because of his unconventional leadership style, the investment momentum encouraged by the preceding government of Noynoy Aquino continued.  At the time the pandemic hit in early 2020, the Philippines investment ratio was close to a 20-year high of about 28 %.  Understandably, the last three years have been more subdued.

            The good news is that Jim thinks that the higher rates of interest now prevailing need not curb the enthusiasm of investors.  The real lending rate is close to zero.  This means that there should be no problem for businesses whose returns are higher than trend nominal GDP growth, thus promoting high return, sustainable investment.  For the period 2010 to 2016 (years under the Nonoy Aquino Administration), real lending rates were -2% or lower.  This gave rise to a malinvestment boom, businesses imprudently investing in nonprofitable ventures.  No such dangers exist now.  Whatever bullishness one observes among investors is found in the so-called “sunshine” sectors, especially based on a large domestic market of some 115 million Filipinos—bolstered by ever growing remittances from OFWs and earnings from the BPO-IT industry.  To be continued