YEARENDER: Capital inflow issues take center stage

MANILA, Philippines - Concerns on capital inflows took center stage this year with the Bangko Sentral ng Pilipinas (BSP) taking charge of seeing to it that the influx of foreign investments won’t result in asset bubble formations and excessive peso appreciation.

Industry officials were one in crediting the BSP for a job well done, but also stressed tougher challenges are up ahead in 2013 as developed markets Europe and the US remain unattractive to investors as policymakers there continue to get their act together to solve the debt crises.

 “I think the BSP has done an excellent job ensuring the exchange rate did not move radically in any direction since that would be disruptive,” said Raul Victor Tan, president of the Money Market Association of the Philippines (MART), in a text message. MART is an association concentrated on developing the capital markets.

The Philippines has enjoyed good investor sentiment throughout the year as a result of its strong macroeconomic performance. With strong growth and slow inflation, BSP’s concerns have shifted from that of fast rise in consumer prices to that of excessive currency strength and property lending.

“On inflation, there’s not much BSP had to do because prices were tame,” Tan said. The 3.2 percent inflation as of November falls at the lower-end of the official three  to five-percent target for the year.

Portfolio inflows

 Focus shifted to portfolio inflows which could be easily taken in and out of the bond and stock markets and as such, could create serious disruptions to financial activity. BSP data showed these inflows hit a two-year high of $1.088 billion in November.

Portfolio investments- also called “hot money” for the ease they enter and exit economies- are also prone to speculation. Higher foreign inflows increase demand for pesos and as such result into the latter’s appreciation. The peso has strengthened by roughly seven percent against the dollar this year.

Since excessive peso appreciation could hurt business activity, the BSP has been intervening in the foreign exchange market by buying up dollars to temper the local unit’s rise. A strong peso trims the value of dollar export earnings and remittances from overseas Filipinos.

Aside from direct dollar buys however, the BSP has unveiled a number of regulations this year targeted at managing inflows to the local economy.

BSP regulations

 In January, the central  bank started off 2012 with a measure increasing capital charges in non-deliverable forwards to 15 percent from 10 percent. The end-goal was to shun speculative inflows in the market, where investors buy out currency contracts and earn profits by settling the difference between the exchange rates during the contracted and settlement dates.

This was followed by another measure six months later, this time at the BSP’s special deposit accounts (SDA). The rule, released in July, banned foreign funds from parking in SDA, a facility BSP said was meant to control local liquidity. SDA are short-term deposits with the central bank paid with interest.

A month after that, BSP decided to shift gears and focus on a more specific sector- real estate lending- and how capital inflows channeled to this may result into asset bubble formation. It lifted all exemptions in the computation of real estate bank exposure and expanded them as well to cover those channeled into securities of property firms for instance.

The concern was that banks may have been lending too much and beyond credit standards that they result into bad loans. These bad loans- unpaid ones especially 30 days after due date- may put pressure on lenders’ balance sheets, causing a bank crisis similar to that of debt-ridden Spain.

But for Antonio Moncupa Jr., secretary of the Bankers Association of the Philippines, an asset bubble similar to that that happened during the 1997 Asian financial crisis is not likely to occur this time around.

 “Looking at the banking industry’s balance sheet, there is no unreasonable loans growth which is the first indication of asset bubbles.  Bank’s leverage is likewise very tame relative to other countries,” Moncupa said in an e-mail.

He also credited the BSP, saying it has “guided the industry quite well” with regulations crafted through a partnership between regulators and industry players.

“In assessing how the BSP regulated the banking industry, I think we should look at the numbers.  From the consistent improvement in the banks’ balance sheet strength in terms of capital adequacy, liquidity, and conservative leverage and likewise its earnings, we could say that the BSP has guided the industry quite well,” he explained.

Policy cuts

 But macroprudential measures just worked as a complementary to BSP’s main move of slashing policy rates by a total of one percent this year. Monetary authorities, comfortable with inflation results, cut key rates to new record-lows of 3.5 percent for overnight borrowing and 5.5 percent for overnight lending.

These rates serve as bank benchmark rates for their loans and as such, lowering them has the effect of lowering bank loan interest charges. The desired effect was simple: to encourage more bank lending to boost consumption and investment, thus growth.

But for Emilio Neri Jr., an economist at the Bank of the Philippine Islands, the same cuts have another effect of capping the peso’s appreciation- something, which exporters are complaining about.

“Like what I’ve said before, if BSP did not act, we could have seen the peso at the 39-peso level,” Neri said. The local unit has been trading at between 40 and 41 to a dollar as of this writing.

For his part, Moncupa said he did not think BSP’s eyes were more on capital inflows than on inflation last year since both are connected to each other.

 “(M)onetary authorities are not forsaking inflation management to control hot money flows.  Inflation is under control. However, now that the economy is growing quite robustly, it is not improbable that inflation expectations could rise as a result of inflows,” he explained.

Moving forward to 2013

 Similar challenges await the BSP next year, but both Tan and Moncupa are confident monetary authorities have the caliber to manage the expected flooding of more foreign inflows.

“The challenge will the same but maybe slightly harder since there are still unresolved issues such as the European crisis and (the US) fiscal cliff which will impact growth externally,” Tan explained.

“In turn, this could be negative for the Philippines,” he added.

But over-all, Philippine growth is expected to hold up, Tan said, and thus, will put pressure on consumer prices. “Price pressures may pick up if growth rates domestically continue at current pace,” he said.

Growth has been at a remarkable 6.5 percent as of the third quarter, higher than the government’s five to six-percent target for 2012. Since growth is driven highly by huge demand, prices of basic goods and services may rise.

Moncupa agreed, but expressed confidence the BSP, as the country’s monetary authority, will be able to pull it off again.