The Philippine Central Bank Has a Dilemma

Updated on
  • Governor had pledged to lower ratio to single digits from 20%
  • Inflation set to pick up this year on back of higher taxes

Nestor Espenilla

Photographer: Veejay Villafranca/Bloomberg

Philippine central bank Governor Nestor Espenilla said it’s getting harder to cut the reserve requirement ratio for lenders as he’d pledged to do when he took office six months ago, with inflation set to pick up.

“We have to be careful that we don’t send the signal that we are lowering the guard in terms of fighting inflation and keeping to our targets,” Espenilla, 59, said in an interview at his office in Manila on Tuesday.

Large banks in the Philippines are required to hold 20 percent of their deposits in reserve, one of the highest ratios in Asia. Espenilla made it one of his key objectives to lower the ratio as part of wider market reforms. While he still wants to bring the rate down -- as early as this year, and eventually to below 10 percent so it’s comparable to peers in Southeast Asia -- he said he can’t risk confusing the market.

“The timing for lowering the reserve requirement is getting harder because of the perception that perhaps inflation might be on the rise,” he said.

Caution

Espenilla is taking a cautious approach on raising interest rates, declining to say whether policy makers are ready to tighten monetary policy as early as the first quarter, as some economists predict. The central bank is still studying the possible effect of higher taxes on inflation projections, he said.  

“I wouldn’t put it as if we’re itching to raise interest rates,” he said. “Right now staff are busy doing surveys and assessing the impact of recent developments to determine if there are secondary effects and evidence of inflation expectations becoming more elevated. It’s a data-driven exercise.”

The governor has fended off calls since last year to raise rates amid a booming economy and a new tax law that raised levies on oil and sugary drinks. He’s been aided by inflation remaining inside the bank’s 2 percent to 4 percent target, but price pressures are rising.

“It may be too early to think of any policy adjustment in the February meeting,” said Jonathan Ravelas, chief market strategist at BDO Unibank Inc. “But they may highlight potential risks to inflation. It could create a reassessment of the inflation path, and if they see a steeper rise in inflation that could mean an earlier rate hike in the first half, maybe as early as the second quarter.”

In December, the central bank forecast inflation will average 3.4 percent this year and 3.2 percent in 2019. Those projections don’t include the effect of a tax law implemented in January, Espenilla said.

“February 8 is going to be an interesting meeting from the standpoint of assessing whether our position last December remains a valid position,” he said. “We said that we can hold policy rates for the time being. What has happened since then? Tax reform happened.”

The government estimated the tax changes could raise the inflation rate by 0.4 to 0.7 percentage points, while ING Groep NV economist Joey Cuyegkeng forecasts a jump of as much as 1 percentage point, and another 1 point increase from indirect effects, such as higher fares, wages and production costs.

Policy makers are always ready to act and “we’re not closed-minded to raising rates if we have to,” Espenilla said.

The central bank is also on guard for signs of an overheating economy. Growth has exceeded 6 percent in every quarter for the past two years, and set to continue booming as President Rodrigo Duterte rolls out a record $180 billion of spending on roads, rails and port projects. Bank loans rose 18 percent in November from a year earlier, while the trade deficit surged to a record.

— With assistance by Karl Lester M Yap

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