OF SUBSTANCE AND SPIRIT

Bloomberg and online news last Tuesday reported a closing rate of ₱58.27 to a dollar, nearly the same level it did on Nov. 8, 2022, and the worst in 18 months. BSP Governor Eli Remolona emailed media to explain that “the peso weakened beyond ₱58 to the US dollar today, in line with other currencies in the region. The dollar continued to strengthen as the Federal Reserve signaled delay in cutting interest rates.”

The governor captured the immediate dynamics of the peso’s weakness but there are more to it, and some could be traced back to the BSP itself.

First of all, no one can fault the US central bank for suggesting that rates may remain higher for longer. It is correct to stay tight because the US economy is robust and resilient, humming with the stock market, while domestic inflation has so far proved stickier at around three percent against the two percent target.

But we read a different story from the broadsheets last Friday.

The BSP announced that it may start cutting interest rates as early as August for a total of 50 basis points (bps), as “recent inflation uptick was not as bad as expected.” To many observers and media reporters, such a statement sounded less hawkish even after the Monetary Board kept the policy rate steady at 6.5 percent.

Such a statement is not exactly in synch with the BSP press statement issued after the Board meeting the day before. Its penultimate paragraph could not be more than hawkish: “The Monetary Board deems it appropriate to ensure sufficiently tight monetary policy settings until inflation settles firmly within the target range. A restrictive policy stance will also help keep inflation expectations anchored amid a possible buildup in upside risks to future inflation.”

As to its institutional commitment, the BSP press statement could not have been more steadfast in reiterating that it “remains ready to adjust its monetary policy settings as necessary, in keeping with its primary mandate to safeguard price stability.”

But to say that the BSP “still has room to cut rates before the US Federal Reserve,” up to a possible 50 bps may confirm that the MB meeting was “dovish.” The market’s demand for US dollar soared and we ended up the other day with the peso’s weakest showing in 18 months.

It is not impossible for some to speculate that monetary policy is less worried about inflation than the prospects of growth. After all, the Development Budget Coordination Committee recently announced lower growth targets of 6 percent-7 percent for 2024 and 6.5 percent-7.5 percent for 2025.

And domestic inflation seems to be about to break through the inflationary spiral of March 2022-November 2023 with the less-than-expected inflation of 3.8 percent in April 2024. If the May 2024 inflation should turn out less than 4.0 percent, then one can safely say price pressures are losing steam, and the issue boils down to how much stronger are the upside risks the BSP identified during last week’s policy meeting.

As proof, the BSP announced risk-adjusted inflation forecasts of 3.8 percent for 2024 and 3.7 percent for 2025 from 4.0 percent and 3.5 percent, respectively. With these solid forecasts, the BSP could have dwelt more on the favorable dynamics of inflation and the impending success of hitting the target after two years. Issuing instead a forward guidance of an August easing when the US Fed looks keen on staying higher for longer is bad timing. After all, a risk-adjusted forecast of 3.8 percent for this year is not exactly “benign.” In our previous lingo at the Board in times past, it is “manageable.”

If the risks identified as upside risks amplify themselves beyond programmed magnitude, the upper end of the target could easily be breached.

And here’s the rub: telegraphing to the market the likelihood of an easier monetary policy in the next few months was enough to upset the foreign exchange (FX) market. Therefore, the crash of the peso beyond ₱58 is not exactly unexpected. Moreover, the situation turned for the worse when the BSP admitted that it was intervening less. Unless the BSP once again affirms its strong commitment to checking market volatility and ensuring order in the FX market, the breach in the ₱58 line in the sand could be further extended.

If the peso further weakens over a prolonged period, the exchange rate pass through could begin to kick in, and inflationary tendencies may resurge. What is “manageable” risk-adjusted forecasts for 2024 and 2025 could be easily beaten. Nobody fancies this.

Yesterday’s report about the country’s April balance of payments deficit of $639 million from March’s surplus of $1.2 billion does not inspire a stable peso. The shortfall derives from the government’s massive debt repayments. Cash remittances from our overseas workers are at best anemic. And the deficit is not true only for the month of April; the first four months of the year also yielded a deficit.

It would not also help the peso and inflation if at this time that monetary policy should remain cautious against a tight US Fed to talk about a possible reduction in the required reserve ratio (RRR) from 9.5 percent to a possible five percent. That will release hundreds of billions of pesos into the monetary stream. True, a high RRR is distortionary of financial intermediation. But its expansionary effects cannot be discounted at this time when aiming for a lower inflation is still imperative.

On the other hand, the market may wish to read the emerging scenario with more care and give the BSP more credit that it is now seeing an early victory against inflation. Our monetary authorities may just be too excited to share to the business community what it intends to do once inflation is firmly under control, reduce policy rate and then by lowering the RRR, infuse the market with more money.