High inflation, weak peso banner challenges faced by BSP

Challenging. This was how Bangko Sentral ng Pilipinas (BSP) Governor Felipe Medalla described 2022.

As domestic economic activity recovered above its pre-COVID level, monetary authorities were challenged by elevated inflation due to the impact of Russia’s invasion of Ukraine and supply constraints due to the lockdowns in China, as well as the weakening of the peso against the dollar amid the aggressive rate hikes by the US Federal Reserve to fight inflation.

Medalla assumed the post of BSP governor and chairman of the seven-member Monetary Board on July 1 after being appointed by President Marcos.

The new BSP chief hit the ground running as the Monetary Board delivered a huge 75-basis-point hike in key policy rates in a surprise off-cycle rate-setting meeting on July 14 to tame inflation and stabilize the peso.

Due to the challenge of making sure that inflation expectations remain anchored, the central bank was forced to start raising interest rates in May instead of the original normalization schedule in the fourth quarter of this year.

After the interest rate liftoff on May 19 with a 25-basis-point hike, the BSP – then headed by now Finance Secretary Benjamin Diokno – delivered another 25-basis-point increase on June 23.

For 2022, the BSP raised interest rates by a total of 350 basis points, bringing the benchmark overnight reverse repurchase rate to a 14-year high of 5.50 percent.

As part of its COVID-19 response measures, the BSP had slashed key policy rates by 200 basis points, bringing the benchmark interest rate to an all-time low of two percent to boost economic activity.

To support the recovery from the pandemic-induced recession, the BSP maintained an accommodative stance between 2020 and May 2022.

Elevated inflation, slumping peso

Medalla is not ruling out further rate hikes even after the first quarter of next year, as inflation is likely to remain elevated and stay above the central bank’s two to four percent target in the first half of 2023.

Inflation shot up to a 14-year high of eight percent in November from 7.7 percent in October, bringing the average to 5.6 percent during the 11-month period.

“I’m almost sure the peak is in December, not January (2023), because the base effects are working in favor in January,” Medalla said.

According to the BSP chief, there is a 50 percent chance that inflation this month could hit a high of 8.5 percent or lower.

“You can never rule it out,” he said.

Based on its assessment last Dec. 15, the Monetary Board sees inflation averaging 5.8 percent for this year but raised its forecast to 4.5 from 4.3 percent for next year.

“Our goal is to have inflation between two and four percent, preferably closer to three percent by the third quarter of next year,” Medalla said.

The expected upside risks to inflation over the policy horizon stem mainly from elevated international food prices due to high fertilizer prices and supply chain constraints.

On the domestic front, trade restrictions, increased prices of fruits and vegetables due to weather disturbances, higher sugar prices, pending petitions for transport fare hikes, as well as potential wage adjustments in 2023 could push inflation upwards.

Meanwhile, the impact of a weaker-than-expected global economic recovery continues to be the primary downside risk to the outlook.

With the easing of global oil and non-oil prices, the negative base effects as well as the impact of the BSP’s tightening cycle, Medalla is confident that inflation would ease closer to the mid-point of the central bank’s two to four percent target range.

By 2024, the BSP   is expecting a lower inflation of 2.8 percent from 3.1 percent.

Medalla said the  Monetary Board arrived at its decision to deliver another 50- basis-point hike last Dec. 15 after noting the further uptick in headline and the sharp rise in core inflation in November amid pent-up demand.

“Amid broad-based inflation pressures, persistent upside risks to inflation, and elevated inflation expectations, the Monetary Board deems it necessary to take aggressive monetary action to bring headline inflation back to within target as soon as possible. At the same time, an adjustment in the policy interest rate will continue to provide a cushion against external spillovers amid tighter global financial conditions,” the BSP chief said.

The BSP has succeeded in addressing the slumping peso by actively participating in the foreign exchange market and through a series of aggressive rate hikes, matching the increases delivered by the US Fed, to maintain a 100-basis point interest rate differential.

Due to the hawkish Fed as well as stronger demand for   dollars to pay for more expensive and increasing imports amid the further reopening of the economy, the local currency has slumped by as much as 15.7 percent to hit an all-time low of 59 to $1 last October.

The peso is now back to the 55 to $1 handle in tandem with other major currencies that continue to strengthen against the US dollar with the expected softer rate hikes by the Fed.

Slower growth

Medalla sees the country’s gross domestic product (GDP) growing within the 6.5 to 7.5 percent growth target set by the Cabinet-level Development Budget Coordination Committee (DBCC) for this year.

“Staff projections for the fourth quarter of 2022 GDP growth indicate that domestic recovery is likely to remain firm. The continued improvements in the industry and services sectors due to the further easing of mobility restrictions as well as reopening of face-to-face classes are seen to drive the sustained expansion. Meanwhile, production losses caused by the recent typhoons could temper agricultural output,” the BSP said.

It added that domestic economic activity has recovered above its pre-pandemic level.

According to the BSP, the economy is projected to operate at slightly above potential as the overall balance of demand and supply conditions provides an indication of potential inflationary pressures.

Estimates from the BSP’s Policy Analysis Model for the Philippines indicate that the output gap is projected to turn positive in 2023, reflecting largely the sustained expansion in 2022, and returning to broadly neutral territory in 2024 as the impact of policy interest rate adjustments take hold on the economy.

BSP Deputy Governor Francisco Dakila Jr. earlier said the impact of the latest 50-basis-point hike delivered this month would dent the GDP growth by seven basis points in 2023 and by 19 basis points in 2024.

Last Dec. 5, the DBCC slashed its GDP growth forecast to a range of six to seven from 6.5 to eight percent between 2023 and 2028 due to the external headwinds led by the projected recession in advanced economies led by the US as well as the tighter financial conditions.

Debt watchers see robust growth

S&P Global Ratings, Moody’s Investors Service, and Fitch Ratings affirmed the country’s investment grade rating as they expect the GDP growth to remain robust after exiting the pandemic-induced recession with an expansion of 5.7 percent in 2021 after contracting by 9.6 percent in 2020.

S&P kept the Philippines rating at BBB+, which is two notches above the minimum investment grade, with a stable outlook.

On the other hand Moody’s Investors Service affirmed the country’s credit rating at Baa2, which is a notch above the minimum investment grade, with a stable outlook, while Fitch affirmed the rating at BBB, which is a notch above the minimum investment grade, with a negative outlook.

S&P sees the GDP growth accelerating further to 6.3 percent this year before slowing down to 5.7 percent next year as slower growth of the world economy would act as economic drags.

On the other hand, Moody’s is expecting a more robust GDP expansion of 6.7 percent for 2022 and 6.4 percent for 2023 driven by pent-up demand with the lifting of strict COVID-19 quarantine and lockdown protocols.

Likewise, Fitch sees a GDP growth of 6.8 percent for this year and 5.5 percent for next year.

A favorable credit rating allows the government to borrow from international creditors at relatively cheaper costs, allowing the government to use the savings from lower borrowing costs to spend more on vital expenditure items, such as infrastructure and social services.

Digitalization, financial inclusion

With the COVID-19 serving as catalyst, the BSP continued to ramp up its digitalization and financial inclusion initiatives to achieve its twin goals of raising the share of electronic payments to total retail transactions to 50 percent and increasing the number of Filipino adults with bank accounts to 70 percent by 2023 under the Digital Payments Transformation Roadmap.

The share of digital payments to total retail transactions increased to 30.3 percent last year from a year-ago level of 20.1 percent, while the number of banked Filipino adults almost doubled to 56 percent in 2021 from 29 percent in 2019.

“Not only do we believe that digitalization will increase efficiency and improve governance, but we also see it as a way to expand financial inclusion. In fact, promoting inclusive digital finance is the first objective under the National Strategy for Financial Inclusion 2022–2028. We have come a long way in our digital finance transformation journey,” Medalla said during the GCash Digital Excellence Awards last Dec. 1.

The BSP has also signed a memorandum of understanding (MOU) on regional payment connectivity at the sidelines of the G20 Leaders’ Summit held in Bali, Indonesia last month.

“The MOU concretizes the collaborative approach to enhancing cross-border payments in the Association of Southeast Asian Nations,” BSP Deputy Governor Mamerto Tangonan said.

More challenges

Despite the projected slowdown in the economic growth next year, Medalla reiterated that the Philippines is not likely to slip into recession anew.

“The question is not a recession but the extent to which growth will decline… It’s low growth, not a recession. By low growth, I mean here anything lower than five (percent),” Medalla earlier said in a television interview with CNBC Asia.

Last September, multilateral lender International Monetary Fund (IMF) slashed its GDP growth forecasts for the Philippines to 6.5 from 6.7 percent this year and further to five percent for next year as the confluence of global shocks weigh on the economy.

Medalla reiterated that the BSP remains steadfast in its commitment to its primary mandate of sustaining price and financial stability.