Bangko Sentral ng Pilipinas (BSP) Governor Felipe M. Medalla said the BSP policy rate should at least be more than 100 basis points (bps) higher than US Federal Reserve rates to ensure stability in the peso-US dollar exchange rate.
“Our own finding is at the very least, Philippine policy rates should be at least 100 bps higher (than) US interest policy rates to have some form of exchange rate stability,” said Medalla during the Philippine-US dialogue with US-based investors on Saturday, Oct. 15 (Manila time) on the sidelines of the ongoing International Monetary Fund-World Bank Annual Meetings in Washington DC.
Medalla, who presented the Philippine monetary policy agenda along with the economic team led by Finance Secretary Benjamin E. Diokno, said there are a lot of things complicating the Philippine monetary policy right now including a depreciating peso. The peso broke P59 vis-à-vis the US dollar three times this month.
“We are fighting inflation and in addition, the US battle against inflation is forcing the currency of the Philippines to depreciate so that we have to also raise the interest rates,” said Medalla.
“So, there are two reasons (for higher policy rates) one is we have our own inflation problem, the other one is we are forced to respond to the policy rate of the (US) Fed. The Fed might raise its rates by two more 75s and one more 50,” he added.
Since May this year, the BSP has raised the key rate by a cumulative 225 bps. That was done in five policy meetings in a row including one off-cycle rate hike in July. As of Sept. 22, the central bank benchmark rate stood at 4.25 percent versus the US Fed’s 3.25 percent.
Since price stability is a key BSP mandate, the rate hikes were intended to primarily bring back the inflation path to within the two percent to four percent target range by 2024.
For this year, the average inflation forecast is 5.6 percent and for 2023, it is 4.1 percent. The January-September inflation is currently averaging at 5.1 percent, with the highest rate recorded in September at 6.9 percent. At a 5.6 percent inflation forecast, the BSP rate of 4.25 percent is still low and in negative rate territory.
Medalla said the objective is to have a predictable and low inflation by 2024. He is confident though that “by next year it will normalize and the supply shocks will not create very high inflation expectations.”
For now, the BSP had to respond to US Fed rate increases. All currencies are depreciating versus the US dollar since a higher US rate favors the mighty greenback.
Medalla said the peso is in the middle of the pack compared to other depreciating currencies. He maintains the peso is not fundamentally weak, supported by remittances and earnings from the business process outsourcing sector. “But despite this, the currency is under pressure,” he said.
“We have responded by adjusting interest rates. High prices of oil and non-oil products increased the need for the US dollar. There are many products where you need 50 percent more dollars to buy the same things abroad,” said Medalla.
“Luckily we have large reserves,” he added. The country’s US dollar stock has decreased to the $95-billion level as of end-September versus end-2021 level of $108.8 billion.
“We’re selling reserves. When we sell reserves, we increase dollar supply. The other thing it does is it reduces peso supply,” said the BSP chief.
Medalla assured investors that the BSP is engaging all its monetary policy tool kits to manage inflation and temper exchange rate pressures.
The BSP is doing “necessary measures (to control inflation) including raise interest rates to match US Fed actions, hopefully not too much. Hopefully the Fed will pause,” said Medalla.
During the Philippine-US dialogue, Medalla reiterated that the local economy can handle the BSP rate increases.
“Fortunately the economy is strong enough to withstand the rate increases. A 25 bps (rate) increase will cut growth rate by five basis points. It’s a strong economy with very strong demand. If tourism bounces back that will more than offset the effect of the rate increases,” said Medalla. The government expects the economy to grow by at least 6.5 percent for 2022.