Philippines Maps Policy Shift to Avert 1997 Risk: Southeast Asia

The Philippines is stepping up its battle against surging capital inflows with a plan to shift to a multiple interest-rate policy regime, as stocks at a record and the peso near a five-year high heighten asset-bubble risks.

Bangko Sentral ng Pilipinas will probably use the rate on special deposit accounts and the overnight lending rate to supplement its benchmark as tools to guide policy, according to Australia & New Zealand Banking Group Ltd., Citigroup Inc. and Nomura Holdings Inc. All 16 economists in a Bloomberg survey predict the key borrowing rate will stay at 3.5 percent tomorrow.

Governor Amando Tetangco, who has imposed limits on lenders’ currency forward positions and expanded monitoring of real estate loans to fight inflows, said yesterday the central bank is moving to an interest-rate corridor approach. Capital volatility poses a risk for Asia-Pacific economies, Standard & Poor’s said last week, raising the potential for asset and credit bubbles 15 years after the 1997-98 financial crisis.

“The Philippines is under pressure to adjust its monetary policy approach to deter capital inflows” and reduce the cost of absorbing excess funds in the financial system, said Johanna Chua, Hong Kong-based head of emerging Asia economic research at Citigroup. “Traditional inflation targeting with a single interest rate as its main policy tool is now being challenged because of abundant global liquidity and further monetary accommodation in advanced economies.”

Initial Step

The Philippine stock index has risen almost 17 percent this year and climbed about 300 percent since October 2008, making it the world’s biggest equity bull market. The peso, which is the best performer in the past year among emerging-market currencies tracked by Bloomberg, touched 40.55 per dollar today, close to its highest level since March 2008.

The yield on 6 percent bonds due March 2016 fell three basis points, or 0.03 percentage point, to 2.61 percent, according to midday fixing prices at Philippine Dealing & Exchange Corp. That’s the lowest rate for a three-year benchmark note since Bloomberg began tracking the data in October 2000.

Bangko Sentral will probably add to cuts on the rates on $46 billion of funds in its special deposit accounts, according to economists at Citigroup and Barclays Plc. The rate, currently at 3 percent, was lowered below the benchmark in January for the first time. The overnight lending rate is 5.5 percent.

The decision to reduce rates on SDAs was an “initial step towards transitioning” to an interest-rate corridor and further cuts can’t be ruled out, Tetangco said last week. Such a move would be one of the most important policy shifts since Bangko Sentral adopted inflation targeting in 2002, said Emilio Neri, an economist at Bank of the Philippine Islands in Manila.

Liquidity Surge

Bangko Sentral has intervened to manage the peso, Tetangco said on Jan. 15, as the currency approached its strongest levels since 2008. A liquidity surge drove the interbank overnight rate to negative this year, while money supply increased 10.84 percent in January, the fastest pace in 19 months.

Net portfolio inflows were almost six times higher in January compared to December, spurred by funds including Manulife Asset Management and Western Asset Management Co. The Southeast Asian nation will be among the 10 fastest-growing economies in 2013 and 2014, according to Bloomberg surveys.

“Low rates increase the attraction of taking on leverage, particularly when growth and confidence are high,” ANZ said in a Feb. 27 note. “It is further compounded by inflows associated with the perceived run-up to an investment grade rating.”

Improved Governance

President Benigno Aquino is increasing spending to a record this year while seeking more than $17 billion of investments in highways and airports to spur growth to as much as 7 percent. Standard & Poor’s in December raised the country’s sovereign rating outlook to positive, citing improved governance and public finances, bringing it closer to investment-grade status.

The situation is different from 1997, when the Philippine peso slumped about 52 percent as the financial crisis spread in the region. The economy slid into a recession in 1998, and the government borrowed from the World Bank and the International Monetary Fund to contain the impact.

Now, encouraged by the nation’s growth prospects, value of land in Manila’s Makati business district has surpassed the 2008 peak, and will rise 5 percent to 8 percent more in the next 12 months, Colliers International UK Plc said in a note last month.

“The high-end property sector is seeing relatively sharp asset price gains which may soon be addressed through additional controls such as reducing banks’ maximum exposure to property, adjusting loan-to-value ratios, limiting single ownership,” economists at Nomura said.

Managing Volatility

Last year, Bangko Sentral announced limits on lenders’ currency forward positions, banned overseas funds from special accounts and expanded monitoring of banks’ real-estate exposure. The central bank has “instituted formal mechanisms” to avoid asset-price inflation, especially in real estate, Deputy Governor Nestor Espenilla said March 8.

Other Asian nations are also boosting efforts to contain inflows. South Korea Deputy Finance Minister Choi Jong Ku in January said authorities should consider taxes on currency trading and bonds, while Thailand is setting up a team of economists to study how to respond to short-term capital inflows.

For the Philippines, reducing the SDA rate may be the preferred option, according to Barclays.

“A lower SDA rate reduces the central bank’s sterilization costs, giving it more freedom to manage currency volatility via spot intervention,” said Prakriti Sofat, a regional economist at Barclays in Singapore. “It also reduces the return for banks’ excess liquidity, encouraging them to expand credit in the economy.”

Before it's here, it's on the Bloomberg Terminal.