Steady

The BSP decided last Thursday to hold all policy rates steady. The stock market responded with a rally, bringing up the PSEI to well above the 8,000-point level.

Many had expected our monetary authorities to follow the lead of the US Federal Reserve. The Fed, days before, raised its policy rates by a quarter of a quarter of a percent. The Dow Jones index dropped by three percent in a day following that decision, abetted in part by fears of a trade war erupting after President Trump decided to impose punitive tariffs on Chinese exports.

Expectation for the BSP to raise rates was stoked by what seems to be an inflationary surge in our own economy. The depreciation of the peso, firmer oil prices and the effects of new excise taxes (in that order) combined to produce an uptick in inflation.

By choosing to hold our interest rates steady, the BSP is telling us that while inflation may be elevated, it is not chronic. Our monetary authorities are betting the inflation rate should normalize toward the end of the year.

There might be some debate over this assessment. Some think that the first job of the BSP is check inflation and shoot an inflationary surge on sight. Our inflation rate is currently running, depending on the method used for calculating it, either slightly above four percent or slightly below this upper range of BSP forecast.

 Had the BSP decided to raise interest rates, however, that will likely have the effect of moderating the pace of our economic growth. Government is pushing for a GDP growth rate of seven percent by heavily investing in new infrastructure and attracting more investment inflows. The strategy is to shift our economy from consumption- to investments-led growth conducive to making wealth creation more inclusive.

The end goal of rapid, investments-led growth is to bring down poverty incidence to 14 percent by 2022. Lower poverty incidence, increased investments in education and health and improved job creation for the millions of young Filipinos about to enter the workforce will, in turn, produce a strong platform for sustained economic expansion far into the future.

By holding interest rates steady, the BSP throws its support behind government’s rapid investments-led growth strategy.

Raising interest rates would have started a chain of business decision-making with the effect of slowing down growth. To begin with, it will raise the costs of money, leading investors to think twice about borrowing to start a business. The higher cost of money poses a challenge to the viability of enterprises.

In the financial markets, higher interest rates could cause a shift from stocks to fixed-rate instruments. That will diminish the market capitalization of our corporations and, since government is a net borrower, saddle the fiscal side with higher debt servicing.

The BSP appears to have decided that the inflationary risk is not so severe as to cause it to adopt interest rate policies that will slow down our pace of growth. There is nothing that shows that our economy is under imminent threat of overheating.

Trade war

Meanwhile, a new source of uncertainty clouds the outlook for the global economy: the possibility of a trade war escalating and therefore constricting growth prospects.

The Trump administration has been on a tariff-slapping binge. Last month, the US imposed tariffs on imported aluminum and steel even as American manufacturers themselves are resisting this move.

By imposing tariffs on steel and aluminum, Trump may have been targeting China. But China is not among the top ten exporters of these commodities to the US. Washington eventually ended up exempting key allies (and major exporters) such as Canada, Mexico, the EU and Australia.

Last Thursday, Trump announced punitive tariffs on a yet unspecified range of Chinese exports. Beijing responded in kind, saying that if Trump wants a trade war they were ready to fight this to the end.

Barely anyone in Washington agrees with the decision to punish China with tariffs. The world’s second largest economy is a major trading partner for the US. Beijing is a key US partner in maintaining stability in Northeast Asia.

Beyond those facts, China is a major creditor to the Americans, holding hundreds of billions of US debt paper in its vaults. Should China decide to dump the debt paper it holds, this will result in unimaginable chaos in US financial markets.

Beijing, ever pragmatic, is not likely to do that, of course. If it releases debt paper in bulk to the market, prices would fall. Because of their holdings, China is the last country to want to see the dollar fall.

The Chinese are as much prisoners of the many commercial and financial entanglements as the Americans are. Trump and his gang seem to have difficulty understanding that.

But Beijing could retaliate where it hurts. American exporters of soya and sorghum depend on competitive access to the massive China market. They could find that access restricted in the coming period.

America’s most iconic products, such as the iPhone, are produced almost entirely in China. A trade war between these two large economies could undermine the viability of these products.

No one is sure what the real objectives of Trump’s tariffs are beyond pleasing his political base. They will not create an impressive number of new jobs for American workers. Nor will they protect the obsolete jobs already threatened.

It is more likely that the tariffs will make it more difficult for American manufacturers to be price competitive. A trade war will only slow America’s growth deep into the future.