The Bangko Sentral ng Pilipinas’ (BSP) flexible exchange rate policy is an effective “shock absorber” while foreign exchange (FX) interventions help manage inflation and ease pressures on monetary policy, according to the International Monetary Fund (IMF).
The BSP’s reserves have declined mostly because of FX interventions since July this year. It intensified when the peso depreciated to its record low of P59 last Sept. 29. With BSP’s presence in the spot market, the peso-US dollar rate has stabilized at the P56 level, so far.
The IMF estimates the country’s gross international reserves will settle at $94.1 billion by end-2022, lower than BSP’s own projection of $99 billion. As of end-October, the GIR stood at $94 billion after it fell to $93 billion in September.
Next year, the IMF expects the country’s reserves to drop to $88.7 billion and by 2024, the GIR could further decline to $83.9 billion. It did not provide reasons why it thinks the reserves will continue to decrease in the next two years.
“Monetary policy should be the first line of defense against persistent inflationary pressures,” said IMF in a concluded 2022 Article IV Consultation with the Philippines. However, it has also assessed that “under a scenario of disruptive market conditions and tightening FX liquidity, the use of FXI (FX interventions) can mitigate a sharp and disorderly exchange rate depreciation, alleviate inflation, and reduce some of the pressure on monetary policy.”
The GIR has already lost $13.69 billion from $107.69 billion at the start of 2022. The BSP intervenes in the spot market to strengthen the peso by releasing US dollar liquidity which it withdraws from the country’s reserves.
BSP Governor Felipe M. Medalla has said that the Philippines still has ample GIR to allow them to sell dollars and help smoothen FX market volatility. A stable exchange rate is also positive for inflation management.
For this year, the IMF estimates local inflation will climb to 5.3 percent, then decelerate to 4.3 percent in 2023 and 3.1 percent in 2024. The BSP’s own forecast is 5.8 percent for 2022, but has the same 4.3 percent and 3.1 percent projections for 2023 and 2024.
As of end-October, inflation has averaged at 5.4 percent after hitting a 14-year high of 7.7 percent in October. For November inflation, the BSP estimates a range of 7.7 percent to 8.2 percent.
The IMF said further monetary tightening will ensure inflation expectations are well anchored but the BSP “should aim at bringing the policy rate close to the neutral real rate to securely bring inflation within the target range” of two percent to four percent.
It added that “clear communication about inflation and the BSP’s policy intentions can help reduce uncertainty and improve policy transmission”
Since May this year, the BSP has raised the benchmark rate by a cumulative 300 basis points (bps), or from two percent to five percent by Nov. 17. The market expects another 50 bps rate hike on Dec. 15 after the BSP signalled earlier that it will continue to match US Federal Reserve actions for as long as there is high inflation and a depreciating peso.
“Exchange rate flexibility remains important as a shock absorber against the backdrop of a persistent terms of trade shock and a wider current account deficit. Policies will have to remain nimble, carefully balancing growth and price stability objectives, while managing limited fiscal buffers, preserving financial stability, and ensuring external sustainability,” said the IMF.
It added that the “coordinated use of fiscal, monetary, and exchange rate policies can help alleviate policy tradeoffs under downside risk scenarios.”
The IMF also said that “calibrating the policy mix to preserve macroeconomic stability, enhancing fiscal and financial resilience, and accelerating structural reforms are critical to sustain the recovery.”
In September, the IMF announced its growth forecast for the Philippines of 6.5 percent for 2022 and five percent for 2023. It also projects a medium-term economic growth of 6.3 percent. For 2024, it forecasts six percent real GDP growth.
The IMF expects the current account deficit to increase to five percent of GDP this year but will decreased to 1.7 percent of GDP over the medium term.
“With a difficult global environment weighing heavily on the economy, the economic outlook is subject to significant downside risks, where policy tradeoffs between supporting output on the one hand and reducing inflation and safeguarding the external position on the other, would become more acute,” said the IMF.