The Bangko Sentral ng Pilipinas (BSP) is reportedly poised to increase interest rates. In the United States, the Federal Reserve Bank is also planning to increase interest rates because it believes that the US economy is already stable and increased rates will not have any negative effects on economic growth. Is this also the same reason why our BSP is planning to increase interest? It seems to me the answer is “no.”
The conventional wisdom is that the BSP is planning to increase rates because of the fear of increasing inflation.
Inflation refers to sustained prices of goods and services in an economy over a period of time. When the price levels increase, then each peso buys fewer goods and services which economists refer to as a reduction in the purchasing power of consumers and investors.
A recent monetary report states that consumer prices in the Philippines rose by 4.5 percent year on year in April 2018. This is the highest inflation rate since November 2011. The highest inflation in the Philippines was recorded at 62.89 percent in September 1984 during the Marcos martial law regime. The record low was 2.10 percent in January 1959.
In the April 2018 inflation figures, prices of food and non alcoholic beverages increased by 5.9 percent, the highest since October 2014. Alcoholic beverages and tobacco rose by 20 percent; clothing and footwear by 2.2 percent; housing, water, electricity, gas and other fuels rose by three percent; furnishings, household equipment and routine maintenance by 2.8 percent; health by 2.8 percent; recreation and culture by 1.5 percent; and restaurant and miscellaneous goods and services by 3.4 percent. The only good news came from two sectors: communications which rose by 0.3 percent and education by only 1.8 percent.
The original inflation target of the BSP for 2018 was a range of two to four percent. There were recent reports that claimed the BSP had changed its inflation target to 4.5 percent.
So why is the BSP reportedly planning to increase interest rates? If GDP growth is picking up but inflation is rising with it, the boom cannot last long because at some point – sooner rather than later – the Central Bank will have to raise interest rates to dampen demand and subdue inflation. The economic dilemma confronting economic planners is that recent figures show that there has been a slight increase in unemployment. If interest rates go up, this will reduce consumption of goods and services leading to reduced sales of businesses. It will also make borrowing costs higher. The combination of these two – reduced sales and increased borrowing costs – could lead to companies postponing expansion plans and may even lead to reducing capacity. This will lead to less hiring or even laying off employees.
Another effect of inflation is that it discourages savings because it erodes the value of money sitting idly in a bank or bonds. This will lead to the shrinking of money available to invest. Inflation, especially increases in food and fuel prices, have also led to political instability.
The challenge is controlling inflation while ensuring that economic growth is not hampered. According to Ruchir Sharma, author of The Rise and Fall of Nations: “I found that in the postwar era , low inflation has been a hallmark of very long runs of strong economic growth. Nations that post long runs of strong economic growth are almost always investing a large share of their national income and that investment creates the supply networks that keep inflation low. China, Japan, South Korea and indeed all the Asian miracles followed this model. Heavy investment drove economic growth while inflation was kept in check.
On my list of the 56 nations that since 1960 have posted runs of more than six percent for at least a decade, nearly three out of four had inflation rates lower than the emerging world average over the course of their run. This pattern held even in less celebrated booms like Kenya’s in the 1970s and 80s or Romania between 1971 and 1984 when inflation averaged just over two percent or 18 percent below the emerging world average during that period...
A high rate of inflation is a cancer that kills growth attacking the living organism of the economy through several channels... The general rule is that low consumer price inflation is an indispensable buttress of steady growth. Any period of high growth can be doomed if it is accompanied by rapidly rising inflation. High growth is even more durable if consumer prices are rising slowly or even if they are falling as a result of a positive supply shock or good deflation.”
The other related challenge for the BSP is how to ensure that the Philippine peso remains a stable currency. Economists believe that the ideal currency value is a market-determined cheap currency in a stable financial environment underpinned by low inflationary expectations . This combination will give local businesses the confidence to build, banks, the confidence to disburse loans at reasonable rates, and investors, the confidence to make long term commitments to the rest of the nation.
In the final analysis, the confidence or lack of it in the economy will be determined by the Filipino investors. According to Sharma: “Capital flight begins with locals. I suspect because they have better access, intelligence to local conditions.“
Hopefully, the BSP and our economic managers will be able to control inflation and reduce unemployment while sustaining the present economic growth all at the same time.
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Young Writers’ Hangout on May 12, 19, 26 and June 2 (1:30 pm-3 pm; independent sessions) at Fully Booked BGC. For details and registration contact 0945-2273216 or writethingsph@gmail.com.
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