Damaging

The global markets now await the US Fed’s interest decision. It has been raising interest rates continuously the past several months.

In the past, when mercantilism was the dominant economic paradigm, nations used trade to impoverish rival economies. This came to be known as the “beggar-thy-neighbor” policy that enabled economies with more marketable commodities to exchange them for precious metals that held their value. The trade imbalances doomed economies with weaker trade positions.

Today, in place of trade, it does seem that interest rates have emerged as the weapons of choice to conserve one country’s economic strength compared to others. In a way, an interest rate war replaces the old trade war paradigm.

Whatever decision the Fed takes will influence decisions on monetary policy everywhere else. Nations are scrambling to find the optimal interest rate levels to curb inflation without excessively damaging growth prospects.

Recent interest rate increases by the US Fed produced a strong dollar, forcing other currencies to depreciate. We see that in the decline of our peso’s exchange value, now hovering around P56:$1.

The US Fed, as are the world’s other central banks, is principally mandated to conserve price stability in the domestic market. Calibrating interest rate levels is the most effective instrument for inflation targeting. Other instruments, though not entirely useless, do not deliver predictable results.

In the latest reports, inflation in the UK has hit double-digits. The British will likely jack up their interest rates to prop up their currency and push back inflation.

The US Fed will likely beat them to the draw, continuing its interest rate increases to solve its own inflation problems. This will leave the British pound and the Euro comparatively weaker – a factor, compounded with soaring energy costs, that will make recession nearly certain in this part of the world.

Last week, our own BSP raised interest rates further by 50 basis points. That brings up our policy rates to 3.75 percent, a level many businessmen consider prohibitive.

BSP Governor Felipe Medalla says inflation in our economy will peak in the fourth quarter. That could be read to mean more upward adjustments in the policy rates will be forthcoming, probably bringing up our main interest rate measure to about 4.5 percent. At that level, the cost of money will surely cramp our ability to grow.

Higher interest rates will increase the profitability of our banks – but only if investors keep on borrowing. The early indications are that businesses will now borrow less. That means less employment will be created. That creates the peril of stagnation.

Although interest rates are reliable weapons to curb inflation, there is a lag time of about six months to achieve their intended effects. We will not know until the fourth quarter if the first rounds of interest rate increases could deliver their intended effects.

Our inflation outlook is a lot less predictable than most other economies. This is because much of the inflation is delivered by the cost-push of some basic goods.

The cost of oil is the principal driver of inflation, of course. Because we import nearly all of our oil needs and pay for them in dollars, movement in global prices is magnified by the depreciation of the peso.

Oil, unfortunately, is not entirely driven by market forces (that could have made them easier to forecast). The war in Ukraine is the main culprit driving the spike in energy costs. No one knows how long the war will last.

While slower growth in China and fears of a deep recession in Europe pressed down oil prices last month, the reluctance of major oil exporters to jack up their production caused prices of this vital commodity to rebound the past few days.

Add to the inflation we import through oil the effects of the many inefficiencies in our domestic economy we left unaddressed the past few decades. The current controversy over sugar is illustrative of this.

The latest numbers show that domestic sugar prices are now four times prevailing prices in the more efficient sugar producers. Expensive sugar drives up the prices of many other commodities such as bakery products and beverages.

How long can we sustain this anomaly of sugar priced at more than four times what the commodity costs in other economies? This will kill our food processing sector, the only truly bright spot in our manufacturing. We will tend to import more processed food from our neighboring economies, putting greater pressure on our balance of trade and balance of payments.

If we had not liberalized rice trading, this staple commodity would be priced at over a hundred pesos a kilo – approximating the price of rice in Japan’s highly protected domestic rice market. Historically, rice prices were a major driver of inflation. Liberalization cured that.

Today, the prices of other agricultural goods – such as onions, carrots, chili and garlic – drive inflation. The inefficiency that we allowed to persist in our agriculture now bites our consumers back.

Unfortunately, higher interest rates will not cure the inefficiencies of our agricultural sector. The higher cost of money will only serve to discourage new investments in mechanization and industry that our domestic economy truly needs.

Adjusting monetary policy is the easiest thing. Undertaking the structural changes many parts of our economy need is far more complex and politically challenging.

There are other drivers of inflation beyond the reach of monetary policies. They must be addressed as well.