Bangko Sentral ng Pilipinas (BSP) Governor Felipe M. Medalla may have hinted his preference for a reduction in banks’ reserve requirements (RR) first before implementing a policy rate cut to avert currency depreciation pressures. In an interview with British publication The Banker, of which a clip was provided by the BSP to the media on Wednesday, May 10, Medalla reiterated his views on policy rate cuts and its timing, and the impact of any rate reduction on the exchange rate. He said that while the decelerating inflation will convince the Monetary Board to pause and hold, and then to cut key rates eventually, there is another BSP toolkit that can also stimulate the economy without affecting the peso rate, and that is reducing the RR ratio. The RR is the percentage of bank deposits and deposit substitute liabilities with the BSP that are not for lending. “Fortunately, we have other ways of stimulating the economy, other than the interest rate because in the past we had very high reserve requirements. One way to stimulate the economy without reducing the difference between our policy rate and the US policy rate is to cut reserve requirements. So, we still have tools,” said Medalla. He added that BSP continues to have adequate reserves and well able to defend the peso against other currency-related pressures. “We have more than adequate reserves. The problem is every time the US policy rate becomes very close to ours – and very close is 100 bps (basis points) to 125 bps – the peso tends to weaken,” said Medalla, referring to the interest rate differential between US and BSP rates. He added – “a hypothetical question is what if our inflation falls faster than the US? Should we cut? One scenario is despite the fact that our inflation is falling faster than the US, we may be more reluctant to cut because cutting may result in significant peso depreciation.” This is where Medalla said that instead of a rate cut, the BSP could do the RR ratio reduction first, as a way of encouraging growth without the threat of a peso depreciation. But, even if the peso weakens versus the US dollar, Medalla reiterated that BSP has the reserves to prevent undue exchange rate pressures. “On the other hand, if the narrowing of the interest rate differential results in excessive depreciation of the peso, our experience show that (with adequate reserves) we sell part of it and eventually it convinces the markets that the peso is not as weak as they thought it would have been,” he said. In 2022, when the US Federal Reserve started its jumbo rate increases of four 75 bps, the peso vis-à-vis the US dollar depreciated by 14 percent as of October from January of the same year. To defend the peso, the BSP raised its policy rates equally aggressively and also sold US dollars. The BSP unloaded eight percent of the country’s reserves last year or about $8 billion around October. The peso fell to its lowest rate on record of P59 on Sept. 29. Medalla said with inflation coming down, the latest was 6.6 percent for April from 7.6 percent in March, there will be more options going forward of when to stop its year-long monetary policy tightening bias. “Right now, unless there are large changes in US interest rates, I think we’re alright. And listening to what the Fed is saying, they will no longer (have) large changes in the policy rate and in fact they may pause after their last increase of 25 (bps),” said Medalla. He also emphasized that inflation which started to climb in March 2022 was mostly due to supply shocks from both foreign and domestic sources. But these supply shocks have started to die down following BSP’s “very” aggressive policy actions, said Medalla. “Demand is no longer contributing to inflation and the supply shocks are beginning to wane,” he added. Medalla expects inflation to fall below four percent before the end of 2023 and to average around three percent in 2024. Inflation has been easing after the BSP raised the policy rate by a cumulative 425 bps from May 19, 2022 until March 23 this year. The benchmark rate is currently at 6.25 percent. A BSP policy meeting is scheduled on Thursday, May 18. The market expect the BSP to pause its rate hikes next week. In anticipation of a pause, the peso has been relatively stable at the P55 level these past weeks.