Inflation and interest rate

To raise or not to raise! It seems simple basic economics calls for the BSP MB to move on interest rates to tame rising inflation. But it isn’t that simple. What the BSP MB does tomorrow is still up in the air.

Should the BSP MB succumb to pressures from bankers to raise interest rates? Not too fast, some analysts like my friend John Mangun says.

True, the inflation rate has breached expectations. But it is cost push in nature, possibly a temporary effect of TRAIN 1. Raising interest rates will not help moderate this kind of inflation. This is not the classic demand driven inflation that can be theoretically moderated with a rise in interest rates.

In a cost push situation, higher interest rates will just increase borrowing costs for businesses, consumers, and even the government. Since consumers have no choice but to pay for basic goods and services, the higher cost will be passed on in terms of higher prices.

As a senior citizen partly living off interest on investments, I like higher interest rates, at least higher than inflation. But increasing the interest rate negatively affects everyone else, including government.

The cost of servicing government’s debt burden goes up. Before we know it, government will ask for even higher taxes because their budgets are no longer adequate.

For ordinary folks, consumer loans, including credit card purchases, will become more expensive to repay. Small and medium scale entrepreneurs employing the most number of Filipinos will hesitate to expand because of higher borrowing costs. Some may even cut back their business.

The other cause of today’s higher inflation is oil prices. Raising domestic interest rates won’t make it go down. Maybe it will help moderate peso forex rate depreciation and minimize impact of rising oil prices at the pump. But the effect may not be too significant.

If the impact of TRAIN 1 is deemed temporary, maybe the BSP MB can decide to still do nothing. But the pressure from bankers is so intense they will probably move even a little just to quiet them down.

But there is danger in prematurely raising interest rates in a cost push situation. It may stall investment in businesses that create new jobs. The BSP must be careful they don’t deliver a wrong message and discourage entrepreneurs. We could end up with stagflation, a stagnant economy suffering high inflation, and that will truly hurt the economy and the common man.

One market analyst’s view forecasts two rate hikes this year: “Our full-year 2018 inflation rate forecast under the new CPI series (2012=100) is +4.2 percent (YTD 2018: +4.0 percent; 2017: +2.9 percent). We maintained our view of two hikes of +25bps each this year, with the first hike now expected as early as next week, if not in June 2018, followed by the second hike at end-4Q 2018…”

The analyst explains the interest rate hikes will “anchor inflation expectations, the second-round effects and avoid inflation becoming broader-based from the implementation of TRAIN tax reforms as well as to mitigate the risk to inflation from the persistent weakness in PHP against the USD.”

But BSP Deputy Governor Diwa Guinigundo isn’t as sure. He told reporters the central bank’s medium-term outlook – or for 2019 – remains consistent with the government target of between two percent and four percent.

“If indeed inflation is expected to revert to target path, then why move at this point?“ Guinigundo told reporters last week.

The BSP Department of Economic Research expects the inflation rate in April to settle within the 3.9 percent to 4.7 percent range, while the Department of Finance (DOF) expects it to be at 4.5 percent in April.

An economic bulletin sent by the DOF to reporters observed that “price movements, nevertheless, appear to be normalizing as shown by the declining month-on-month change: 0.7 percent in February to the 0.5 percent forecast in April.”

BSP Governor Nestor Espenilla is also trying to calm down expectations of a higher inflation trend. Espenilla said that while the April inflation figure was on the high side of the central bank’s forecast, seasonally adjusted month-on-month inflation decelerated. He said “expectations seem to be feeding off essentially cost-push price pressures that may be transitory in nature.”

The central bank’s policy settings have remained unchanged since September 2014, when it raised the key rate by 25 basis points. It set the rate at three percent in June 2016 when it moved to an interest rate corridor framework.

The BSP has been keeping an accommodating policy stance through low interest rates to support our growing economy, which has registered growth for 76 quarters to date. 

Tourism industry

A tourism industry leader reacted to our column last Monday to say that they are not as dependent on government’s promotion budgets as we think.

“The private sector spends its own money for promotions like participation in trade shows and roadshows abroad. DOT/TPB is charging the hotels/travel agents, tour operators, airlines, and tourism entities a participation fee of $1,000 to $2,500 and we pay our own hotel, airfare, and other travel expenses. It is the government officials who attend for free, charging all expenses to the huge travel budget of DOT.

“Nagagalit na nga kami kasi there is no marketing direction and no planning. That’s why our travel expenses become higher. Budget of DOT is spent on booth, materials, but mostly on their five star hotels, airfares, and per diems/travel allowance, etc.

“Private sector entities like Plantation Bay are the ones bringing in the tourists. Frustrated nga kami sa mga katulad ni Cesar Montano. He still doesn’t understand tourism promotion. Puro film at sports and fashion show not relevant to bringing tourists here ang ginagawa niya.

“Kaya kailangan imbestigahan din ang DOT/TPB how they disburse the funds.”

Boo Chanco’s e-mail address is [email protected]. Follow him on Twitter @boochanco.