Philippines’ Duterte Pays Price as Central Bank Policy Kicks Inby
New rate framework shows signs of working as market rates rise
10-year bond yields forecast to rise to 5.3% by fourth quarter
The Philippine central bank’s new monetary policy tool is proving effective -- at the government’s expense.
Deposit auctions introduced by Bangko Sentral ng Pilipinas designed to absorb an influx of funds from overseas workers are helping to lift yields on treasury bills and bonds. The central bank started offering them in June as part of a new interest-rate framework, following more than a seven-year period of three-month bills paying less than its benchmark rate.
While the auctions are proving a success, they add to risks of higher borrowing costs for President Rodrigo Duterte, as inflation also takes off. He’s seeking to finance a record budget amid plans for an ambitious infrastructure program. Economists surveyed by Bloomberg predict the 10-year government bond yield will be 5.3 percent by the fourth quarter, compared with 4.2 percent now.
“The years of ultra-cheap borrowing costs for the government are over,” said Jonathan Ravelas, chief market strategist at BDO Unibank Inc. in Manila. “The new framework is steering market rates towards the policy rate. While it is causing higher costs for the government, the benchmark rate is becoming more relevant for market players and the economy. It is now a stronger tool.”
Policy makers announced they were cutting the benchmark rate, narrowing the band around it and introducing the new deposit tool in May last year. The changes were designed to move low “sticky” market rates closer to the benchmark. The key rate will probably be held at a record-low 3 percent at a meeting on Thursday, according to all 17 economists in a Bloomberg survey.
The framework was enforced due to “excess liquidity in the system, because you have a lot of volatility in market rate,” Bangko Sentral Deputy Governor Diwa Guinigundo said in an interview. “That’s bad for the transmission of monetary policy and that’s bad for decisions to be made by investors and banks themselves. We wanted to guide market rates closer to the policy rate.”
The central bank is achieving its aim. The yield on the 91-day T-bill increased to 1.998 percent in an auction last week, the highest since August 2015. And this week, the government sold three-year bonds at the highest yield since at least 2013.
“Interest rates in the primary T-bill market over time are also expected to gradually align with short-term market rates and with the BSP policy rate,” Guinigundo said separately in an e-mailed response to questions. “The national government will have less room to continue rejecting high bids from auction participants. Otherwise, fewer banks will be inclined to participate in the government securities auctions.”
The volume of term deposits the central bank offers has surged sixfold to 180 billion pesos ($3.6 billion) per week as total bids exceeded auction volumes. That’s the same amount the government plans to borrow this quarter. The rate on the 28-day deposit, the longer of the two tenors available, increased to 3.41 percent this week from 2.5 percent when it was first sold.
“Increasing the volume of term deposits offered is one way the central bank can tighten policy without raising interest rates,” said Emilio Neri, economist at Bank of the Philippine Islands in Manila. Bangko Sentral is forecast to be among the first in Asia to raise rates this year, as early as this quarter.
To gauge the effectiveness of the rate framework, the central bank also looks at the migration of funds to term from overnight deposits, Guinigundo said. The term facility held 610 billion pesos as of Jan. 17, about three times the amount in overnight deposits, he said. Since June, overnight deposits have shrunk about 80 percent to 216 billion pesos.
Offering longer tenors may be considered in the future, depending on the liquidity needs and preferences of the market, Guinigundo said.
The government had 6.1 trillion pesos of debt at the end of 2016, with domestic borrowings accounting for 65 percent. The amount of local borrowings planned for this quarter is 33 percent more than the previous three months and the highest since at least 2014.
Duterte may need to borrow more should lawmakers fail to pass changes to tax laws to boost revenue. The president is embarking on a $160 billion infrastructure program to help sustain economic growth rates of close to 7 percent, among the fastest in the world. He is widening the budget deficit to 3 percent of gross domestic product from a goal of 2 percent under the previous administration.