OF SUBSTANCE AND SPIRIT
It is good to remain watchful of the impact of sustained increases in oil prices on output and inflation following the Ukraine-Russia war and whatever is left of the Organization of Petroleum Exporting Countries or OPEC’s leverage in oil pricing dynamics.
History is our teacher.
During the first oil crisis from October 1973 to January 1974 that was spurred by Yum Kippur, oil prices escalated from $2.90 to $11.65 per barrel. Arab members of the OPEC imposed an embargo against the United States for supporting Israel against Egypt and Syria. Western Europe and Japan were not also spared.
The second oil crisis of 1979 was quite different. A revolution was fought and won in Iran against the Shah. Oil was priced at $39.50 per barrel, nearly three and a half times its value at the end of the first oil crisis. There was panic buying and it was not uncommon to see long queues at gas stations.
With oil prices skyrocketing, output slumped in the US, Western Europe and Japan so significantly that the global economy plummeted by three percent in 1979. In emerging markets like the Philippines, we experienced both massive inflation and economic slowdown.
Inflation rose from 15.7 percent in 1973 to 32.2 percent in 1974. Prices accelerated by 7.0 percent in 1978 to 17.4 percent in 1979 and 17.6 percent in 1980. There was diminution of the Filipinos’ purchasing power.
Our real GDP slowed down from 8.8 percent in 1973 to 3.4 percent in 1974. During the second oil crisis, output growth was almost steady, rising a bit from 5.2 percent in 1978 to 5.6 percent in 1979. In the next two years, the economy slackened to 5.2 percentin 1980 and 3.4 percent in 1981.
We saw this experience repeated in 2018 when the BSP was more aggressive in the face of enormous adjustments in oil prices. Inflation averaged 5.2 percent during the year, breaching the 2-4 percent target.
But growth remained robust, decelerating only from 6.9 percent in 2017 to 6.3 percent and 6.1 percent in 2018 and 2019, respectively.
Then as now, stubbornly high fuel prices triggered second round effects through higher wages and transport costs. With Dubai crude oil prices estimated to average around $100 in 2022 and 2023, we see higher risks coming from new wage orders approved for nearly all regions starting June 2022. Provisional fare increases were also cleared for public utility jeepneys in the National Capital Region, Regions 3 and 4.
Through all these, the BSP Monetary Board (MB) and economists have been smart in navigation. They did not disappoint last meeting. In their meeting today, even if they do a 50-basis point adjustment, they remain accommodative given the large differential between inflation, averaging 4.1 percent for January-May 2022, and the policy rate at 2.25 percent. With growth probably averaging 6-7 percent this year, the economy’s absorptive capacity could not have been greater.
Such bullishness is consistent with the BSP’s own press statement last Friday reiterating the economy’s fundamental strength, and the World Bank’s assessment that it does not see stagflation as a risk for the Philippines. Oxford Economics also weighed in by listing the Philippines as second least vulnerable among 18 emerging markets to stagflation.
This morning, we expect the BSP staff to submit to MB several risks to the inflation outlook. The hostilities in Eastern Europe and their impact on logistics and supply chain are likely to be prominent. Thus, the balance of risks would likely remain tilted to the upside. With May’s inflation at 5.4 percent, the previous forecasts of 4.6 percent for 2022 and 3.9 percent for 2023, could be exceeded by the new forecasts, both of which would likely breach the 2-4 percent target for both years.
True, the BSP’s focus is price stability. However, the market can be assured that the BSP is as concerned with inflation as with its drivers. Unfortunately, a weak peso is one of them. Intervention in the foreign exchange market would be at best palliative. We should look instead into why the peso has been rapidly depreciating in the last couple of months and what can be done about it within the parameters of BSP’s flexible inflation targeting framework.
Incoming Governor Philip Medalla is correct in saying that doing a balancing act remains crucial. The economy does not have to be the sacrificial lamb to a strong currency. Although the short-term trade-off is between growth and inflation, stable inflation promotes good output performance over time. Thus, the suggestion for a less accommodative stance is not to strengthen the peso, but to convince the market that the BSP is serious about keeping inflation firmly on track and growth prospects more sustainable.
After all, the BSP knows that the pass-through of the exchange rate to inflation has decreased over the years.
All up, risks to growth do not necessarily come from a tight monetary policy. Growth today can stall because of external forces — not the least of which include the Russian invasion, high energy prices, supply chain disruptions, and lower consumer confidence. China’s lockdown is not helping any.
This must be the underlying reasoning behind the recent survey conducted among 750 executives including 450 chief executive officers in Asia, Europe and North America. More than 60 percent of them expect a recession in their respective regions within the next 12-18 months. Some 15 percent “say their region is already in recession.”
With an overheating economy and a delayed monetary action, the more aggressive move by the US Fed simply upped the ante for economic contraction.