THE PHILIPPINES’ fiscal approach may require adjustments to accommodate increasingly severe supply disturbances, the International Monetary Fund (IMF) stated.
“Looking forward, fiscal policy may need to modify in response to more regular and intense supply-side disturbances,” the IMF mentioned in its most recent Staff Report for the 2024 Article IV Consultation.
“Inflation trends in the Philippines have been defined by a more pronounced effect of supply elements over demand elements in recent years, partly due to the Philippines’ significant dependency on imports of energy and food, limited application of price regulations, and susceptibility to detrimental climate occurrences.”
The IMF noted that the “frequency, intensity, and durability” of acute supply disturbances may escalate in the future attributable to climate change and increasing geoeconomic fragmentation.
The Philippines has been the most vulnerable nation globally for 16 consecutive years, according to the latest version of the World Risk Index.
The nation is generally impacted by numerous storms and other extreme climate events throughout the year, resulting in billions of pesos worth of destruction to agriculture and infrastructure.
“The BSP (Bangko Sentral ng Pilipinas) must be cautious in ‘looking through’ these factors to ensure second-round consequences do not cause a dislodgment of inflation expectations,” the IMF cautioned.
Inflation surged since 2022 due to a spike in global commodity rates and disruptions in supply chains. The Philippines’ annual inflation averaged 5.8% in 2022 and 6% in 2023.
FOREX INTERVENTION?
The IMF expressed that the foreign exchange rate could function as a “shock absorber,” while foreign exchange intervention (FXI) may be suitable in specific scenarios.
“Shifting anticipations regarding forthcoming policy rates in the US have heightened peso volatility. The BSP has been rightfully concentrating on domestic price stability, allowing the exchange rate to fulfill its function as a shock absorber, and should persist in doing so,” it added.
Thus far this year, the peso has dropped to the P59-per-dollar mark on three occasions. The BSP has indicated that it is closely monitoring the peso and has been somewhat more proactive than usual in the markets.
“Given the Philippines’ shallow FX markets — the most pertinent IPF (Integrated Policy Framework) friction — and the nonlinear impact of exchange rate variations on inflation expectations, FXI can assist in alleviating risks associated with sudden exchange rate fluctuations.”
“However, the implementation of FXI should only be temporary and should not replace necessary macroeconomic policy modifications.”
The BSP has indicated it only intervenes to limit speculation and ensure market orderliness.
“Moving forward, when contemplating the optimal reaction to periods of stress and high uncovered interest rate parity premia, the BSP should remain aware of the tradeoffs between utilizing FXI and deepening the domestic foreign exchange market.”
Meanwhile, the IMF also highlighted the importance of “ensuring coordination across various facets of the BSP’s toolkit.”
“While total assets have diminished, the BSP still holds a considerable portfolio of government securities acquired during the COVID-19 reaction. This has enabled the BSP to transition to a variable-rate/variable-amount reverse repurchase (RRP) framework, with the target RRP rate aligning with the policy rate.”
“Going forward, the BSP could effectively communicate a strategy regarding the size of its balance sheet during normal conditions… to provide greater clarity to market participants.”
It acknowledged the central bank’s recent action to reduce the reserve requirements, noting that it will lead to a favorable decrease in financial intermediation expenses and align reserve requirements more closely with regional counterparts.
“Revisions to the reserve requirement ratio (RRR) must be integrated into the overall monetary policy position and synchronized with any alterations in the BSP balance sheet size,” the IMF remarked.
As of October this year, the BSP lowered the RRR for universal and commercial banks as well as nonbank financial entities with quasi-banking functions by 250 basis points to 7% from 9.5%.
The IMF also acknowledged the initiative to reactivate the interest rate swap (IRS) market and establish a benchmark yield curve to “further develop the Philippines’ fixed income and money markets and enhance monetary policy transmission.”
“The authorities’ recent effort to create an improved peso IRS market based on the RRP will assist businesses and banks in managing local interest rate risk.”
Last month, the central bank introduced the peso IRS market, succeeding the publication of the updated International Swaps and Derivatives Association. This is part of its initiatives to deepen the capital markets.
“The fragmentation of the yield curve at the short end with yields on government securities significantly lower than those on BSP bills remains a barrier for precise valuation of working capital, which also restrains the progression of the IRS and derivatives markets,” the IMF stated.
“Coordinated actions by both the Bureau of the Treasury (e.g., by increasing issuance at maturities beneath 365 days) and the BSP (e.g., by broadening access to nonbanks and ensuring that BSP bills can serve as collateral) are vital to address yield curve fragmentation and enhance monetary policy transmission.” — Luisa Maria Jacinta C. Jocson
