Monetary policy addresses current macro challenges

During the last Monetary Board meeting (May 10), the Bangko Sentral decided to raise the basic interest rate governing domestic lending transactions by 25 basis points.

In effect, the basic interest rate governing overnight borrowing will rise from three percent to 3.25 percent. Such a move indicates the monetary policy response to pressure points that are currently showing themselves to economic policy makers.

Note that I refer to pressure points rather than “challenges.” In the present context, challenge is too strong a word to use since it connotes the existence of a problem that persists. The economy is still at a sustainable macroeconomic growth path.

Current pressure points facing the economy. There are several pressure points that deserve careful monitoring: (1) inflation; (2) net expansionary stance of government spending programs; and (3) the balance of payments, or better yet, the peso exchange rate.

All these three areas are themselves interrelated. But it is useful to look at them separately to highlight areas of concern that could be corrected by policy to ease any threatening pressure.

Inflation. The reality of inflationary tendencies has been demonstrated by the recent rise of consumer prices.

A dramatic element of the inflation problem is the recent spike in the price of rice, a major and strong symbolic component of the consumer budget affecting the poor.

The price of rice at retail has actively opened up again the problem of domestic production and import policy. Given the market realities in the international rice industry, liberalizing the importation of rice will bring down and stabilize rice prices. (See my Crossroads column on rice, May 2.)

Of course, the inflationary factor was also due to the one-time impact of the recent tax reform which shifted toward the collection of broad-based indirect taxes.

In this context, a bias for a slight inflationary path will happen until the full effects of the staggered tax increases on energy products are implemented. Since energy is widely consumed across the economy, the tax increases will provide some cost-push across the affected sectors.

The price of energy would be highly susceptible to any new geopolitical developments in the Middle East, especially following the withdrawal of the US from the Iran nuclear deal. The nuclear deal was supposed to help stabilize economic and political relations in that part of the world, but US President Donald Trump’s action unsettles that assumption.

Another reason for the inflationary push is external in nature and is quite important. After years of almost zero-interest rate policy, the US Federal Reserve Board (the American central bank) has decided to follow a path of rising interest rates.

The Fed rate at the end of 2017 was at 1.5 percent (last year of Janet Yellen as chair). The US Fed raised the rate to 1.75 percent in March with more rate increases to come.

The consequence of this new policy is that Philippine interest rates will have to track the US rate. In general, the Philippine rate will have to be higher than the US Fed rate. Otherwise, there is some danger of capital flight of US and other investments from the country. (Of course, the main objective is to attract more foreign investments into the country.)

An expansionary public spending program. The announced fiscal stance is expansionary. The economic plan it to gear toward a rate of economic growth between seven to eight percent per year.

Build Build Build is the program designed to accelerate investments in public infrastructure.

All government expenditure is within a fiscal deficit limit not to exceed three percent of GDP. The main programs of infrastructure construction are to be underwritten by access to development assistance and to foreign and domestic financing.

The credibility of this development program was enhanced by the passage of a major tax reform package recently that has produced significant new public revenues.

The tax reform program is still not finished. A second package is still in the works in Congress and has a good chance of passing. This phase of the tax reform deals with reducing the corporate tax rate together with measures designed to streamline and harmonize tax and investment incentives to improve the business climate.

However, the government’s social programs are rising and some discipline is needed to put them in line. It is essential that the building of the nation’s infrastructure requirements and social spending do not negate each other’s effective directions.

The balance of payments, or the peso exchange rate. The balance of payments responds to what is happening in the overall economy. Its companion indicator is the peso exchange rate.

The balance of payments could go into deficit, if overall expenditures or demand (including those emanating from investments in infrastructure) outstrip the capacity to earn exports or bring in additional overseas remittances from Filipino workers or to fill up borrowings. Past lessons concerning external debt finance hover over the horizon as reminders.

The government has better control of aggregate demand than of supply. The earnings (or aggregate supply of exports and other incomes) are more subject to the ups-and-downs in the world economy.

This lack of symmetry in policy control is not reassuring. The world is currently under threat of witnessing a major trade war between China and the US. Moreover, the geopolitical developments arising from current tensions in the Middle East could escalate to broaden uncertainties. On the other hand, the prospects of a peaceful Korean peninsula future augurs well politically.

Our workers who live abroad are as exposed to the rising uncertainties as are domestic industries engaged in international trade in this unsettled atmosphere.

However, it is well to remind ourselves that government efforts to improve the domestic business climate are taking too long to materialize, giving the impression of lack of will to push the necessary reforms. The clamor to improve the business climate to enable the economy to bring in more foreign direct investments are locked in the stalled debates on constitutional change.

In fact, the peso remaining at the current rate just close to 52 pesos to the dollar appears to be unsustainable during the Duterte administration unless inflation is licked, foreign direct investments rise dramatically, and export and income earnings increase dramatically.

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