Once described as giver of “stability,” the Bangko Sentral ng Pilipinas (BSP), or the Philippine central bank, has tightly guarded the local financial system and inflation during the past six years of overflowing credit in the country. It was not an easy job: 24 positive credit rating actions that allowed the Philippines to move up to investment grade lured more investors to what was once the “Sick Man of Asia.”
In return, cheap credit — driven partly by low interest rates and cheap money printing in the United States and other developed markets — found their way to an economy whose public and private institutions are not trained at absorbing huge amounts of capital. At one point in 2013, the BSP recorded over P2 trillion ($43 billion) parked on then-special deposit accounts. These deposits with the central bank, which feared excess liquidity in the system would trigger fast inflation, were paid interest for practically doing nothing.
From 2013 until now, monetary authorities were also at the forefront of the property boom. Thanks to being true to its reputation for being “proactive” against risks, the BSP thwarted asset bubble naysayers and is now in a better position with new and improved tools at its disposal. Better data is foremost: in 2013, BSP expanded the definition of “real estate lending” to include not only actual mortgages, but even those securities backed by them. Just a few weeks ago, it unveiled the country’s first property index measuring nationwide increases in property values. The maiden reading of 9.2 percent average growth in the first quarter was deemed healthy.
Reforms like these have made BSP stand out against its reactionary counterparts in the region. The Bank Indonesia, for instance, had consistently targeted, to its detriment, the exchange rate with its current and budget deficits. The Bank of Japan, though more subtle, had also advocated a lower yen to fight deflation. Years of moving targets to achieve two percent inflation is just one of the reasons why the so-called “Abenomics” set of policites has been a failure. But the BSP is different. For the past six years, it has met its inflation goals, building its reputation. Its chief, Amando Tetangco, Jr., had even shared this prestige after being named as one of the best central bankers on numerous occasions. He is set to end his second term in 2017.
But, indeed, change is coming. And if the central bank wants to maintain its proactive reputation, it will have to start following the new government’s lead in terms of economic policy. Plans by President-elect Rodrigo Duterte to expand the budget deficit to three percent of gross domestic product means the BSP will also have to put a higher inflation target band of three to five percent. That will mark a return to 2014 when the official goal was the same before the band was lowered to two to four percent last year.
For one, higher government spending means more demand which, in turn, translates into higher price pressures. While incoming budget chief Benjamin Diokno had said that additional expenditures will be funneled into infrastructure, making inflation less of a worry, a history of slow procurement processes suggests otherwise. And if indeed more infrastructure is built, expansion in demand will still be faster than supply, considering the time needed to finish road networks and other infrastructure that will connect harvests to the market. Natural calamities, including the impending La Nina, should also be factored in the consumer price index, the basket of goods and services used to measure inflation.
But above all, BSP will be able to assist the government with a higher inflation target. And this is through the facilitation of faster budget absorption by state agencies. Throughout the outgoing administration of Benigno Aquino III, the government has underspent and failed to hit spending targets. They drew criticisms for this before they could even recover. Because inflation is factored into macroeconomic assumptions, a higher inflation target will allow agencies to not worry about breaching inflation goals as they ramp up spending. Again, this is with the assumption that, at least in the first one to two years, higher spending will not be driven by infrastructure, but other goods and services, which are easier to deploy as the new administration adjusts.
Higher targets will also reinforce BSP’s credibility ahead of an expected increase in U.S. interest rates, which could reverberate across the globe. Slowly, oil prices are inching up, putting local pump prices at risk of an upshot. Bond yields are following. A higher inflation band will be like hitting two birds with one stone: it will give some space for fiscal policymakers to boost the economy without worrying about potential external impacts, while also keeping the Philippines attractive to capital flows.
On the flip side, the Duterte administration’s thrust to improve the countryside will work in BSP’s favor. The Philippines, being an archipelago, badly needs to ensure its strong growth is equitable and spread throughout the country. Food production will be the first to be affected, as 30 percent of the working population is in the agriculture industry. While this may tame inflation, a program to become rice self-sufficient in one to two years clouds this outlook. The ambitious project was targeted by Aquino at a longer time frame of three years — and yet he failed.
Unlike central banks in Japan, the United States, and in Europe, BSP has bucked the trend of moral hazard in recent years. Instead, it was the other way around: the economy’s strength combined with ample government support through better finances gave BSP the chance to undertake reforms in its own backyard. The interest rate corridor, which was launched this month, caps a six-year-long reform program that covered BSP’s capacity to detect risks and prevent them from developing into a full-blown catastrophe.
With Duterte’s plans of higher spending though, plus higher rates abroad and weakening global growth, it would be better for BSP to be more prudent on setting targets for itself. This time, as the primary entity guarding inflation the central bank will be in a good position — and can provide some goodwill — to encourage the government to freely use its funds for faster growth without worrying about breaching too-low inflation targets.
Prinz Magtulis is a journalist covering fiscal policy in the Philippines. He holds a master’s degree in public administration from the Catholic University of Korea.