Monetary policy should guard vs itself

The Bangko Sentral ng Pilipinas (BSP) has done enough and should be more careful in dispensing monetary stimulus or risk financial instability, according to an ex-central bank official.

 “Monetary policy should guard against itself,” said former BSP Deputy Governor Diwa C. Guinigundo, adding that the BSP could take less risks after injecting P1.9 trillion in the financial system since the pandemic began, and reducing the policy rate by as much as 200 basis points (bps) to support economic recovery.

Diwa C. Guinigundo
former BSP Deputy Governor Diwa C. Guinigundo

 Guinigundo was part of the BSP team that created the monetary stability sector (MSS), now called monetary economics sector (MES) and he was head of MSS/MES from 2005 until 2019. Since the amended BSP Charter has expanded the central bank mandate, price stability is not the only job of the BSP, but also financial stability.

 Guinigundo said on Monday that monetary policy “should be more circumspect” and that “excessive use” of its toolkits particularly its rate-setting authority “could compromise financial stability” which will “foster mispricing of risks”.

 “It is easy to get carried away with excessive easing of monetary policy and release extraordinary amount of liquidity in the system because the economy is not doing well. It is in a deep recession. (But) the BSP to me has done enough. It has brought down the policy rate to two percent even as the expected inflation this year and the next two years are 2.4, 2.7 and 2.9 percent, respectively,” said Guinigundo in an online forum, Pilipinas Conference 2020 on “Rebooting the Economy Post-Pandemic: Cushioning the Long Emergency” hosted by Stratbase ADR Institute.

 With the benchmark rate at two percent – the lowest policy rate on BSP record – it is now lower than the inflation rate of 2.5 percent average end-October, which means the policy rate is in the negative territory in real terms.

 “When we keep interest rates too low for too long, that could lead to mispricing of risks (and) setting

the stage for asset price inflation in the near future,” said Guinigundo.

 Guinigundo said the BSP should also resolve banks’ procyclical tendency during the pandemic, and their risk-averse position at a time when the economy needs more credit.

 “It is now important to monitor and talk to the banks to avoid procyclicality because we need credit, but you also have to assure that access to credit is available to both households and business,” he said.

Lending rates, in the meantime, remained elevated despite the accommodative monetary policy stance. When banks are procyclical and risk averse, credit is not flowing. “In short instead of lending, they decided to increase their loan loss provisioning which is natural, but at the same went slow on lending.”

 “What these tells us (is) that it is too early to claim victory over the deep recession,” said Guinigundo.

 For now, Guinigundo said the initial signs of economic recovery remain tentative, especially since the danger of the virus resurgence is still present, as evidenced by what is happening in the US and Europe.

 He said it is also too premature to categorically say that the worse is over as far as a rebound is concerned.

 Guinigundo said it is important that confidence in the government and in the pandemic-hit economy is restored as soon as possible. “It will be unrealistic (to say) that we have already flattened the pandemic and economic activities are on their way to recovery. A resurgence can reverse any initial gains,” he cautioned.

 “Because this crisis is pandemic-induced, restoring confidence is very, very crucial. This will help strengthen the green shoots of economic revival and perhaps nurture additional green shoots. We have to manage the economic scars of lost jobs, lost income and lost productivity. (These scars) will take time to heal and disappear,” he said.

He would not consider the July economic indicators as signs of recovery, he called these initial signs of economic activity as a flash in the pan. But the updates on these numbers after the third quarter, he observed, would point to some “promising improvements” eight months into the pandemic.

 Guinigundo could not say that the worse is over if using as indicators the country’s external sector position. As of end-September, the balance of payments (BOP) remain in surplus of $6.878 billion.

 He said the external sector numbers have already been captured by the poor economic performance in the third quarter real GDP of  a contraction of 11.5 percent. “I’m not sure if these backward looking metrics can be considered as leading indicators for the last quarter of 2020 … the BOP surplus position actually reflect the weakness of the Philippine economy. It reflects the lower demand for imports which is bad, rather than strong exports of both goods and services, as well as the huge availment of foreign loans by the government and private sector,” said the former BSP official.