A high inflation rate of 4.5 percent in 2021 will likely convince the Bangko Sentral ng Pilipinas (BSP) to adjust policy rates earlier to avoid hits on the country’s reserves and to preserve the country’s positive credit rating, according to Ayala-led Bank of the Philippine Islands (BPI).
“The Philippines has managed to keep its credit rating despite the huge contraction last year. One of the metrics that have protected the country from a downgrade is the GIR (gross international reserves) to FX (foreign exchange) debt ratio,” noted the bank’s latest BPI Economic Insights (BPI Global Markets Economic and Financial Markets Research).
“But with the US central bank now hinting at the possibility of tighter policy and with imports now increasing, the country’s GIR could decline substantially moving forward. The BSP might be forced to hike earlier than expected in order to temper the decline in the GIR and protect the country’s credit rating,” said BPI.
BPI forecasts 4.5 percent inflation average for 2021, much higher than BSP’s own estimate of four percent. Both forecasts are above the government inflation target range of two-four percent. The bank’s previous forecast was 4.3 percent.
With the recent FX market movements, BPI sees some BSP monetary adjustments within the year. “Aside from inflation, another factor that could challenge the BSP’s ability to keep interest rates steady is the hawkish tilt of the Federal Reserve (US Fed or Fed),” it said.
The US Fed has hinted a possible rate hike in 2023. “This means there is a chance that the Fed could start tapering its bond purchases in 2022. Expectations of tighter dollar liquidity in the coming months might exert pressure on the peso and drain the BSP’s dollar reserves if the policy rate is kept at two percent,” said BPI. The peso, trading at P47:$1 at the end of June, is now at P49.
“Substantial peso depreciation might force monetary authorities to make some policy adjustments,” said BPI.
“The government has reduced the restrictions in Metro Manila given the recent decline in COVID cases. Thus, we expect a rebound in imports as a result of the reopening. Dollar demand may pick up and the exchange rate may move closer to revisit the P50 level, even if just briefly, later this year,” said BPI. “Meanwhile, the possibility of tighter dollar supply may contribute further to peso depreciation.”
BPI said persistent upside risks will keep inflation in the four-percent level despite non-monetary measures such as reduction in pork tariffs which has not significantly resulted to a lowering of pork prices.
The biggest upside risk is the trending oil price hikes, both global and local. “Upward pressure on global oil prices has persisted amid the reopening of major economies (and) the recent depreciation of the peso will likely result in additional importation costs. With the restrictions on public transport capacity, this might force operators to increase their fares,” said BPI. A rising transport fare will translate to second-round effects.
BPI noted that since high inflation is experienced in other countries including the US, the Philippines as a net importer will be affected by higher prices of products being imported.
“(The) elevated prices in other countries might spill over here especially now that the government plans to import more pork products from abroad. Aside from this, global shipping costs have increased substantially amid the surge in demand for manufactured goods specifically electronic products. The combination of higher global inflation and shipping costs might exert upward pressure on local consumer prices,” said BPI.
The June inflation was lower at 4.1 percent from May’s 4.5 percent. The inflation rate has been at the 4.5 percent-level since March.
The BSP has kept its interest rates at an all-time low of two percent since November 2020.
During its June 24 Monetary Board policy meeting, the BSP said the average inflation will likely settle near the upper end of the two-four percent target range this year. It expects that average inflation will “ease towards the midpoint of the target range in 2022 and 2023” but that the Monetary Board “emphasizes that the continued implementation of direct non-monetary measures will be crucial in mitigating further supply-side pressures on meat prices and inflation.”