Read Full Report - Bangko Sentral ng Pilipinas

71 Pages·2014·1.4 MB·English

i
FOREWORD

T

he primary objective of monetary policy is to promote a low and stable rate of inflation

conducive to a balanced and sustainable economic growth. The adoption in January
2002 of the inflation targeting framework for monetary policy was aimed at helping to fulfill this
objective.

One of the key features of inflation targeting is greater transparency, which means
greater disclosure and communication by the BSP of its policy actions and decisions. This
Inflation Report is published by the BSP as part of its transparency mechanisms under inflation
targeting. The objectives of this Inflation Report are: (i) to identify the risks to price stability and
discuss their implications for monetary policy; and (ii) to document the economic analysis
behind the formulation of monetary policy and convey to the public the overall thinking behind
the BSP’s decisions on monetary policy. The broad aim is to make monetary policy easier for the
public to understand and enable them to better monitor the BSP’s commitment to the inflation
target, thereby helping both in anchoring inflation expectations and encouraging informed
debate on monetary policy issues.

The government’s target for annual headline inflation under the inflation targeting
framework has been maintained at 4.0 percent ± 1.0 percentage point (ppt) for 2014.
For 2015-2016, the medium-term inflation target has been set at 3.0 percent ± 1.0 ppt by the
Development Budget Coordination Committee (DBCC) to be consistent with the desired
disinflation path over the medium term, favorable trends in the structure of inflation, and
expected higher capacity of the economy for growth under a low inflation environment.

The report is published on a quarterly basis, presenting a survey of the various factors
affecting inflation. These include recent price and cost developments, inflation expectations,
prospects for aggregate demand and output, labor market conditions, monetary and financial
market conditions, fiscal developments, and the international environment. A section is devoted
to a discussion of monetary policy developments in the most recent, as well as a comprehensive
analysis of the BSP’s view of the inflation outlook for the policy horizon.

The Monetary Board approved this Inflation Report at its meeting on 2 July 2014.

AMANDO M. TETANGCO, JR.
Governor

11 July 2014

i
List of Acronyms, Abbreviations, and Symbols

AE Advanced economy
AFF Agriculture, Fishery, and Forestry
AHFF Agriculture, Hunting, Forestry and Fishing
AMCs Asset Management Companies
AP Asia Pacific
AL Auto Loans
BAS Bureau of Agricultural Statistics
BES Business Expectations Survey
BGC Bonifacio Global City
BIR Bureau of Internal Revenue
BIS Bank for International Settlements
BOC Bureau of Customs
BPO Business Process Outsourcing
BTr Bureau of the Treasury
CAMPI Chamber of Automotive Manufacturers of the Philippines, Inc.
CAR Capital Adequacy Ratio
CBD Central Business District
CCRs Credit Card Receivables
CES Consumer Expectations Survey
CDS Credit Default Swaps
CI Confidence Index
CPI Consumer Price Index
DAA Deferred Accounting Adjustment
DDA Demand Deposit Account
DBCC Development Budget Coordination Committee
DOF Department of Finance
EIA US Energy Information Administration
EM Emerging Market
EMBI JP Morgan Emerging Market Bond Index
ERC Energy Regulatory Commission
EU European Union
FAO Food and Agriculture Organization
FPI Food Price Index
GDP Gross Domestic Product
GNI Gross National Income
GRAM Generation Rate Adjustment Mechanism
GS Government Securities
ICERA Incremental Currency Exchange Rate Adjustment
IEA International Energy Agency
IMF International Monetary Fund
IPP Independent Power Producer
LFS Labor Force Survey
LPG Liquefied Petroleum Gas
LTFRB Land Transportation Franchising and Regulatory Board
ii
MB Monetary Board
MEM Multi-Equation Model
MENA Middle East and North Africa
Meralco Manila Electric Company
MISSI Monthly Integrated Survey of Selected Industries
MTP Major Trading Partner
NBQBs Non-Bank Financial Institutions with Quasi-Banking Functions
NCCP National Council for Commuters’ Protection
NDA Net Domestic Assets
NEDA National Economic and Development Authority
NEER Nominal Effective Exchange Rate
NFA Net Foreign Assets; National Food Authority
NG National Government
NGCP National Grid Corporation of the Philippines
NPC National Power Corporation
NPI Net Primary Income
NPLs Non-performing loans
NSO National Statistics Office
O&O Offshoring and Outsourcing
OECD Organization for Economic Cooperation and Development
OPEC Organization of the Petroleum Exporting Countries
OF Overseas Filipinos
PBR Performance-Based Rate
PCE Personal Consumption Expenditure
PMI Purchasing Managers’ Index
PSALM Power Sector Assets and Liabilities Management Corporation
PSEi Philippine Stock Exchange Composite Index
PSIC Philippine Standard Industrial Classification
RB Rural Banks
RDA Reserve Deposit Account
REER Real Effective Exchange Rate
ROP Republic of the Philippines
RP Repurchase
RR Reserve Requirement
RREL Residential and Real Estate Loans
RRP Reverse Repurchase
RWA Risk Weighted Assets
SEM Single-Equation Model
SMS Short Message Service
SDA Special Deposit Account
TCS Transportation, Communications, and Storage
TLP Total Loan Portfolio
U/KBs Universal/commercial banks
VAPI Value of production index
VOP Volume of production index
WEO World Economic Outlook
WESM Wholesale Electricity Spot Market

iii
THE MONETARY POLICY OF THE
BANGKO SENTRAL NG PILIPINAS

The BSP Mandate

The BSP’s main responsibility is to formulate and implement policy in the areas of money,
banking and credit, with the primary objective of maintaining stable prices conducive to a
balanced and sustainable economic growth in the Philippines. The BSP also aims to promote
and preserve monetary stability and the convertibility of the national currency.

Monetary Policy Instruments

The BSP’s primary monetary policy instrument is its overnight reverse repurchase (RRP) or
borrowing rate. Other instruments to implement the desired monetary policy stance to
achieve the inflation target include (a) increasing/decreasing the reserve requirement;
(b) encouraging/discouraging deposits in the special deposit account (SDA) facility by banks
and trust entities of BSP-supervised financial institutions; (c) adjusting the rediscount rate on
loans extended to banking institutions on a short-term basis against eligible collateral of
banks’ borrowers; and (d) outright sales/purchases of the BSP’s holdings of government
securities.

Policy Target

The BSP’s target for monetary policy uses the Consumer Price Index (CPI) or headline
inflation rate, which is compiled and released to the public by the National Statistics Office
(NSO). The policy target is set by the Development Budget Coordination Committee (DBCC)1
in consultation with the BSP. The inflation target for 2014 was set at 4.0 percent ±
1.0 ppt. For 2015-2016, the medium-term inflation target was reduced to 3.0 percent ±
1.0 ppt.2

BSP’s Explanation Clauses

These are the predefined set of acceptable circumstances under which an inflation-targeting
central bank may fail to achieve its inflation target. These clauses reflect the fact that there
are limits to the effectiveness of monetary policy and that deviations from the inflation
target may sometimes occur because of factors beyond the control of the central bank.
Under the inflation targeting framework of the BSP, these exemptions include inflation
pressures arising from: (a) volatility in the prices of agricultural products; (b) natural
calamities or events that affect a major part of the economy; (c) volatility in the prices of oil
products; and (d) significant government policy changes that directly affect prices such as
changes in the tax structure, incentives, and subsidies.

1 The DBCC, created under Executive Order (E.O.) No. 232 dated 14 May 1970, is an inter-agency committee tasked
primarily to formulate the National Government's fiscal program. It is composed of the Office of the President (OP),
Department of Budget and Management (DBM), National Economic and Development Authority (NEDA), and the
Department of Finance (DOF). The BSP attends the Committee meetings as a resource agency.
2 The inflation target range for 2015-2016 was announced on 13 December 2012.
iv
The Monetary Board

The powers and functions of the BSP, such as the conduct of monetary policy and the
supervision over the banking system, are exercised by its Monetary Board, which has
seven members appointed by the President of the Philippines. Starting in 2012, the
Monetary Board will hold eight (8) monetary policy meetings in a year to review and
decide on the stance of monetary policy. Prior to 2012, monetary policy meetings were
held every six weeks while prior to July 2006, meetings were held every four weeks
during the 2002 – July 2006 period.

Chairman Amando M. Tetangco, Jr.

Members Cesar V. Purisima
Alfredo C. Antonio
Peter B. Favila
Felipe M. Medalla
Armando L. Suratos
Juan D. De Zuñiga, Jr.
The Advisory Committee

The Advisory Committee was established as an integral part of the institutional setting
for inflation targeting. It is tasked to deliberate, discuss, and make recommendations
on monetary policy to the Monetary Board. Like the Monetary Board, the Committee
will meet eight times a year (beginning in January 2012) but may also meet between
regular meetings, whenever deemed necessary.

Chairman Amando M. Tetangco, Jr.
Governor

Members Diwa C. Guinigundo
Deputy Governor
Monetary Stability Sector

Nestor A. Espenilla, Jr.
Deputy Governor
Supervision and Examination Sector

Ma. Cyd N. Tuaño-Amador
Assistant Governor
Monetary Policy Sub-Sector

Ma. Ramona GDT Santiago
Assistant Governor
Treasury Department

v
2014 SCHEDULE OF MONETARY POLICY MEETINGS, INFLATION REPORT
PRESS CONFERENCE AND PUBLICATION OF MB HIGHLIGHTS
Advisory Monetary Board Inflation Report
MB Highlights
Period Committee (AC) (MB) (IR) Press
Publication
Meeting Meeting Conference
9 (Thursday) 24 (Friday)
Jan
12 Dec 2013 MB meeting Fourth Quarter 2013 IR
3 (Monday) 6 (Thursday)
Feb
AC Meeting No. 1 MB Meeting No. 1

21 (Friday) 27 (Thursday) 6 (Thursday)
Mar
AC Meeting No. 2 MB Meeting No. 2 6 Feb 2014 MB meeting

Apr 24 (Thursday) 28 (Monday)
2 27 Mar 2014 MB meeting First Quarter 2014 IR
2 (Friday) 8 (Thursday)
May
AC Meeting No. 3 MB Meeting No. 3
0
Jun 13 (Friday) 19 (Thursday) 5 (Thursday)
AC Meeting No. 4 MB Meeting No. 4 8 May 2014 MB meeting
1
28 (Monday) 31 (Thursday) 17 (Thursday) 11 (Friday)
Jul
AC Meeting No. 5 MB Meeting No. 5 19 Jun 2014 MB meeting Second Quarter 2014 IR
4 28 (Thursday)
Aug
31 Jul 2014 MB meeting
Sep 5 (Friday) 11 (Thursday)
AC Meeting No. 6 MB Meeting No. 6

17 (Friday) 23 (Thursday) 9 (Thursday) 3 (Friday)
Oct
AC Meeting No. 7 MB Meeting No. 7 11 Sep 2014 MB meeting Third Quarter 2014 IR

20 (Thursday)
Nov
23 Oct 2014 MB meeting
5 (Friday) 11 (Thursday) 8 Jan 2015 (Thursday)
Dec
AC Meeting No. 8 MB Meeting No. 8 11 Dec 2014 MB meeting

vi
CONTENTS

Overview 1
I. Inflation and Real Sector Developments 3
Prices 3
Box Article: Dynamics in the Philippine Rice Market 5
Private Sector Economists’ Inflation Forecasts 8

Aggregate Demand and Supply 12

Aggregate Demand 12
Other Demand Indicators 14

Aggregate Supply 22

Labor Market Conditions 23

II. Monetary and Financial Market Conditions 24
Domestic Liquidity and Credit Conditions 24
Interest Rates 29
Financial Market Conditions 31

Banking System 34

Exchange Rate 37

III. Fiscal Developments 40

IV. External Developments 41

V. Monetary Policy Developments 46

VI. Inflation Outlook 47
BSP Inflation Forecasts 47

Risks to the Inflation Outlook 5 1

VII. Implications for the Monetary Policy Stance 54

Summary of Monetary Policy Decisions 56

vii
OVERVIEW3

Inflation accelerates on higher food and petroleum prices. Year‐on‐year (y‐o‐y) headline inflation rate rose
to 4.4 percent in Q2 2014 from the quarter- and year-ago rates of 4.1 percent and 2.7 percent, respectively.
Nonetheless, the resulting year-to-date (ytd) inflation rate of 4.2 percent remained within the Government’s
inflation target range of 4.0 percent ± 1.0 percentage point (ppt) for 2014. The uptick in inflation was
attributed largely to the faster increase in food prices owing to tight domestic supply conditions. Higher
gasoline and diesel prices as well as tuition fee hikes for the current school year also contributed to the rise
in inflation. Meanwhile, the official core inflation was unchanged at 3.0 percent in Q2 2014. The number of
items with inflation rates greater than the threshold of 5.0 percent (the upper end of the 2014 inflation
target) decreased slightly to 30 in Q2 2014 from 31 items in the previous quarter, but accounted for a higher
proportion of the CPI basket at 28.9 percent compared to 26.5 percent in Q1 2014.

Inflation expectations are stable but are nearing the upper end of the 2015 target band. Results of the
BSP’s survey of private sector economists for May 2014 yielded generally steady mean inflation forecasts for
2014-2016 relative to the results in March 2014. Analysts’ expectations of higher future inflation due to
pending electricity rate adjustments, weakening peso, and higher food prices were tempered by
expectations of capital outflows, which could affect liquidity conditions, due to the possibility that the
US Federal Reserve (US Fed) would soon increase policy rates. Likewise, results of the June 2014 Consensus
Economics inflation forecast survey showed unchanged forecasts for 2014 and 2015.

Domestic demand remains firm. The growth of the Philippine economy decelerated to 5.7 percent in
Q1 2014 but remained above-trend pace. The weaker-than-expected growth reflected largely the lingering
effects of typhoon Yolanda (Haiyan). The slower increase in capital formation on the expenditure side along
with the weaker expansion in manufacturing on the production side likewise contributed to lower output
growth. By contrast, GDP expansion in Q1 2014 was boosted by strong private spending and exports
recovery as well as solid gains in the services sector. Meanwhile, trends in higher-frequency demand
indicators have also remained generally positive in Q2 2014: vehicle sales continued to post double-digit
growth, energy sales rises further, while the composite Purchasing Managers’ Index (PMI) remained firmly
above the 50-point expansion threshold. Similarly, the outlook of businesses and consumers remained
favorable, supporting the continued strength of aggregate demand in the coming months amid robust credit
growth and ample liquidity in the financial system.

Growth prospects diverge across countries contributing to policy uncertainty. Growth momentum in the
US, as evidenced by steady improvements in higher-frequency economic indicators, remained intact
despite the GDP contraction observed in Q1 2014. The euro area is also recovering gradually, but continues
to face the threat of deflation. Meanwhile, the recently-imposed consumption tax increase in Japan could
dampen domestic demand in the near term. A range of indicators likewise point to continued modest
economic growth prospects in major emerging markets (EMs) as the momentum softens further in China,
while the expansion in India remains subdued. Going forward, the global economy is likely to proceed on a
moderate expansion path, with overall growth dynamics more favorable in the advanced economies (AEs).
The balance of risks to the global outlook remains tilted to the downside. Increased volatility in financial
markets ahead of the expected normalization of policy interest rates by the US Fed along with geopolitical
risks in countries such as Iraq, Syria, and Ukraine will likely weigh down on economic activity. Meanwhile,
the global inflation environment remains broadly benign. Inflation pressures in AEs continue to be muted
as output gaps are seen to stay substantial even as the recovery gains pace. However, inflation has risen in
some emerging economies owing to domestic supply side factors.

3 The analysis contained in this report is based on information as of 16 June 2014.
1
Financial market conditions improve following bouts of volatility in early 2014. Confidence in most EM
financial markets returned during the quarter as a result of positive developments on the external front,
including the announcement of targeted measures in China to address the slowing growth momentum and
pronouncements from US monetary authorities to keep policy interest rates at low levels for a
considerable time after the asset purchases end. In the Philippines, reports of strong corporate earnings in
Q1 2014 as well as S&P’s move to raise the country’s credit rating to one notch above investment grade
further boosted investor sentiment. Concerns over escalating unrest in Iraq as well as the increasing
inflation readings for the quarter partly tempered market optimism, but local financial markets managed
to end the quarter on a favorable note. Depreciation pressures eased with the peso appreciating by
1.7 percent quarter-on-quarter (q-o-q), supported by steady foreign exchange inflows and the country’s
ample international reserves. The Philippine Stock Exchange index (PSEi) also rallied to an 11-month high,
averaging 6,738.16 index points in the current quarter. Philippine sovereign spreads likewise narrowed
relative to previous quarter’s average, while the spread on Philippine credit default swaps (CDS) continued
to trade lower relative to the rest of the region. The larger oversubscription in T-bill auctions similarly
pointed to strong investor appetite for government securities (GS), supported by ample market liquidity.
Meanwhile, broadly unchanged bank lending standards for both loans to enterprises and household show
that banks are prudently managing their risks. Going forward, stable global financial conditions are
expected to support further the recovery process.

The BSP maintains key policy rates but adjusts the SDA rate and reserve requirement ratio. The BSP
decided to keep its policy interest rates steady during its 8 May and 19 June 2014 monetary policy meetings
on the assessment that the future inflation path remained within the target ranges over the policy horizon.
However, the BSP raised the reserve requirements for banks (except rural banks) and non-banks with quasi
banking functions (NBQBs) by one ppt effective on 30 May 2014 to help guard against financial stability risks
that could arise from the continued strong domestic liquidity growth and rapid credit expansion. This
followed an earlier one-ppt increase in reserve requirements effective on 11 April 2014. The BSP also
decided to increase the interest rate on the Special Deposit Account (SDA) by 25 bps to 2.25 percent on
19 June 2014 to help mitigate potential price and financial stability risks emanating from ample liquidity.

The prevailing environment for inflation and output suggests that the economy can accommodate
measured adjustments in interest rates. While the latest inflation forecasts continue to be within the target
range over the policy horizon, the baseline inflation path has shifted upward owing mainly to the higher
inflation outturn in May as well as the inclusion of the potential impact of El Niño on food and utility prices.
The current assessment of the price environment also indicates that the balance of risks to the inflation
outlook remains tilted to the upside, with price pressures emanating from the possible uptick in food prices
due to drier weather conditions and pending petitions for adjustments in power rates. Meanwhile, the
downside risk for inflation could stem from slower global economic activity and its impact on commodity
prices. Likewise, inflation expectations remain manageable, but are edging toward the upper end of the
2015 target range.

Domestic liquidity growth—while still elevated—has declined of late. Data for April showed that M3 growth
fell to 32.1 percent in line with the path projected by the BSP. The recent adjustments in RR and SDA facility
are seen to further mitigate the inflation risk from strong liquidity growth.

Notwithstanding the softer first quarter GDP growth, domestic demand conditions remain solid. Aggregate
demand is expected to continue to expand on the strength of robust consumer spending, increased fiscal
spending, and favorable business and consumer sentiment. Sustained growth in investments and fairly
strong expansion in bank lending activity indicate that domestic demand conditions will likely remain fairly
resilient, suggesting that there is room for measured adjustments in interest rates—if warranted—without
unduly dampening economic growth. Meanwhile, the prospects of second-round effects of supply-side
pressures will require close monitoring given elevated food inflation. Going forward, the BSP will remain
vigilant against a potential build-up in inflation expectations and financial imbalances. The BSP stands ready
to undertake further policy actions as necessary to safeguard its price and financial stability objectives.
2