Inflation Report Q2 2006 Report/Attachments... · 2020. 6. 15. · Nelly F. Villafuerte Alfredo C....
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INFLATION REPORT Second Quarter 2006 Bangko Sentral ng Pilipinas
Transcript of Inflation Report Q2 2006 Report/Attachments... · 2020. 6. 15. · Nelly F. Villafuerte Alfredo C....
INFLATION REPORT
Second Quarter
2006
Bangko Sentral ng Pilipinas
FOREWORD
he primary objective of monetary policy is to promote a low and stable rate of inflation conducive to balanced and sustainable economic growth. The adoption in January 2002 of the inflation targeting framework for monetary policy was aimed at helping fulfill this objective.
One of the key features of inflation targeting is greater transparency, which means
greater disclosure and communication by the BSP of its policy actions and decisions. This Inflation Report is published by the BSP as part of its transparency mechanisms under inflation targeting. The objectives of this Inflation Report are: (i) to identify the risks to price stability and discuss their implications for monetary policy; and (ii) to document the rigorous economic analysis behind the conduct of monetary policy and convey to the public the overall thinking behind the BSP’s decisions on monetary policy. The broad aim is to make monetary policy easier for the public to follow and understand and enable them to better monitor the BSP’s commitment to the inflation target, thereby also helping both anchor inflation expectations and encourage informed debate on monetary policy issues.
The government’s targets for annual headline inflation under the inflation targeting
framework have been set at 4.0-5.0 percent for 2006 and 2007. The report is published on a quarterly basis, presenting a survey of the various
factors affecting inflation. These include recent price and cost developments, prospects for aggregate demand and output, monetary and financial market conditions, labor market conditions, fiscal developments, and the international environment. A section is devoted to the BSP’s view of the inflation outlook during the policy horizon. This is followed by a discussion of the implications of the assessment of inflation and economic conditions on the monetary policy settings of the BSP. This issue also features a box article on our recently-approved changes in the BSP’s inflation targeting operating procedures.
The Monetary Board approved this Inflation Report at its meeting on 13 July 2006.
AMANDO M. TETANGCO, JR.
Governor
July 2006
T
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THE MONETARY POLICY OF THE BANGKO SENTRAL NG PILIPINAS
The BSP Mandate
The BSP’s main responsibility is to formulate and implement policy in the areas of money, banking and credit, with the primary objective of maintaining stable prices conducive to a balanced and sustainable economic growth in the Philippines. The BSP also aims to promote and preserve monetary stability and the convertibility of the national currency. Monetary Policy Instrument
The BSP uses the overnight repurchase (RP) rate and reverse repurchase (RRP) rate as the key policy rates to set the monetary policy stance. These two interest rates are typically adjusted in tandem by the Monetary Board. Policy Target
The BSP uses the Consumer Price Index (CPI) or headline inflation rate (which is compiled and released to the public by the National Statistics Office (NSO)) as its target for monetary policy. The policy target is expressed in the form of a range for a given year and is set by the Development Budget Coordination Committee (DBCC) in consultation with the BSP. For 2006-2007, the government’s targets for annual headline inflation have been set at 4.0-5.0 percent. BSP’s Exemption Clauses These refer to the predefined set of acceptable circumstances under which an inflation-targeting central bank may fail to achieve its inflation target. These clauses recognize the fact that there are limits to the effectiveness of monetary policy and that deviations from the inflation target may sometimes occur because of factors beyond the control of the central bank. Under the inflation targeting framework of the BSP, these exemptions include price pressures arising from: (a) volatility in the prices of agricultural products; (b) natural calamities or events that affect a major part of the economy; (c) volatility in the prices of oil products; and (d) significant government policy changes that directly affect prices such as changes in the tax structure, incentives and subsidies.
The Monetary Board The powers and functions of the Bangko Sentral, such as the conduct of monetary policy and the supervision over the banking system, are exercised by its Monetary Board, which has seven members appointed by the President of the Philippines. Beginning in July 2006, the Monetary Board meets every six weeks to review and decide on the stance of monetary policy. Prior to July 2006, monetary policy meetings by the Monetary Board were held every four weeks.
Chairman Amando M. Tetangco, Jr.
Members Romulo L. Neri
Vicente B. Valdepeñas, Jr.
Raul A. Boncan
Juanita D. Amatong
Nelly F. Villafuerte
Alfredo C. Antonio
The Advisory Committee The Advisory Committee was established as part of the institutional setting for inflation targeting. It is tasked to deliberate, discuss and make recommendations on monetary policy to the Monetary Board. The Committee meets regularly every six weeks (beginning July 2006) but may also meet in between the regular meetings, whenever it is deemed necessary. Prior to July 2006, the Committee met every four weeks.
Chairman Amando M. Tetangco, Jr.
Governor
Members Diwa C. Guinigundo Deputy Governor Monetary Stability Sector
Nestor A. Espenilla, Jr. Deputy Governor Supervision and Examination Sector
Ma. Ramona GDT Santiago
Managing Director Treasury Department
Editha S. Alido Director Department of Economic Research
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CONTENTS
Overview 1
I. Inflation and Real Sector Developments 3
Prices 3
Aggregate Demand and Supply 10
Labor Market Conditions 17
II. Monetary and Financial Conditions 18
Interest Rates 18
Financial Market Conditions 21
Banking System 22
Exchange Rate 27
Monetary Aggregates 29
Fiscal Developments 29
III. External Developments 31
IV. Monetary Policy Developments 36
Box: Changes in the Operating Procedures of Inflation Targeting 38
V. Inflation Outlook 40
Inflation Forecasts 40
Risks to the Inflation Outlook 42
Private Sector Economists’ Inflation Forecasts 45
VI. Implications for the Monetary Policy Stance 46
VII. Concluding Remarks 47
OVERVIEW
Price pressures have started to ease as indicated by the deceleration in inflation in the second quarter. The CPI data for the quarter showed slower price increases for food, beverage and tobacco (FBT) and non-food items. Core inflation likewise decelerated during the quarter suggesting limited demand-based pressures on consumer prices.
There are improvements in overall economic activity as suggested by favorable
outturns in selected indicators. On the demand-side, consumption spending continued to be the main driver of growth while sustained growth in industry and services, as well as the upturn in agriculture boosted the supply-side. Confidence in the domestic economy also improved as shown in the results of the BSP surveys. Nevertheless, there were still soft spots in the domestic economy. Unemployment rate remained at double digits based on the old definition while investments continued to be weak.
Domestic interest rates rose during the quarter. Primary and secondary market
rates of government securities tracked a rising trend in the second quarter. This reflected market expectations of continued increases in foreign interest rates as well as concerns over volatilities in the financial market. Meanwhile, bank lending rates closely tracked the movements in the bellwether Treasury bill (T-bill) rates.
Growth in domestic liquidity accelerated. Expansion in liquidity continued to be
driven by inflows from overseas Filipino workers (OFW) remittances and direct investments. These factors allowed the BSP to build up its reserves and reduce its foreign liabilities. At the same time, improvement in banks’ net foreign asset position and the growth in credits to the public sector in May, particularly credits to local government units (LGUs) and other public entities in the form of loans and investments, contributed to the pick-up in liquidity growth.
The peso weakened against the US dollar. The recent volatility in capital flows in
emerging and global financial markets, triggered by concerns over the possibility of stronger-than-expected inflationary pressures and interest rate hikes in the US, weighed down on the local currency.
Global economic momentum continued to broaden. The United States and China
remained as the main engines of global growth while Japan and the Euro area began to show clear signs of recovery. However, there are risks to the ongoing global economic expansion. These include soaring oil prices, continued deterioration in the global current account imbalance, and prospect of high interest rates as monetary authorities continue to tighten their policy stance.
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Monetary policy settings were left unchanged during the quarter. At all its
meetings during the second quarter, the Monetary Board decided to keep policy rates steady as the path for inflation going forward continued to suggest a deceleration in inflation towards the target in 2007. In addition, core inflation and other recent data also continued to paint a scenario of limited demand-based pressures in the near-term. These conditions suggested an outlook of manageable inflation over the policy horizon.
Nevertheless, the balance of risks to the inflation outlook remains tilted toward
the upside, linked mainly to movements in oil prices. The prospect of continued oil price increases over the next few months, along with expected adjustments in domestic power costs, points to a continuing environment of supply-side pressures. Such a prospect increases the risks to inflation expectations and the likelihood of second-round effects, particularly on wage-setting.
Managing the risks to inflation expectations, and the risk of potential second-
round effects in wage- and price-setting, remains a key policy priority. Given some uncertainty about the extent of likely wage increases in the private sector, developments in the wage front will require closer monitoring. Good communication also remains important for managing expectations. Monetary authorities will need to clearly convey their readiness to act upon the evidence of escalating risks to the outlook for inflation and to inflation expectations of the public. At the same time, given that price pressures remain rooted in the supply side, public discussion of policy responses to high oil prices should be directed towards the role of non-monetary measures that can more directly address the impact of increased transport and energy costs.
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I. INFLATION AND REAL SECTOR DEVELOPMENTS
Prices
0
2
4
6
8
10
12
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Headline Inflation Quarterly average in percent (2000=100)
Price pressures eased in the second quarter as indicated by the deceleration in headline inflation. Indices for food, beverage and tobacco (FBT) and non-food items posted slower price increases during the quarter.
Positive developments continued to cushion the impact of on-going supply-related price pressures coming from increases in world energy prices and the impact of the Reformed Value Added Tax (RVAT) Law on consumer prices. For example, the recovery of agricultural production led to a moderation in food inflation. In addition, the relative stability of the peso also helped keep down domestic prices of imported commodities such as oil. Moreover, there was also no firm evidence of demand-based price pressures as output indicators continued to suggest some softness in demand conditions. This assessment was further supported by the easing in core inflation.
Headline and Core Inflation
-2
0
2
4
6
8
10
12
14
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Headline Inflation Food Inflation Non-food Inflation
Headline, Food and Non-food Inflation Quarterly average in percent (2000=100)
M
Average headline inflation eased to 6.9 percent in the second quarter from 7.3 percent in the previous quarter and 8.2 percent in the same quarter a year ago. Inflation for FBT was lower at 5.9 percent compared to 6.2 percent in the previous quarter. Likewise, non-food inflation declined to 7.9 percent from 8.4 percent in the previous quarter. Compared to their year-ago rates, FBT inflation and non-food inflation were lower by 0.9 percentage point and 1.5 percentage points, respectively.
Headline inflation eases in the second quarter.
Price increases for both food and non-food indices moderate during the quarter.
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Of the 6.9 percent average inflation rate for the second quarter, 2.7 percentage points were attributed to food alone. Fuel, light and water contributed 1.0 percentage point while services contributed 1.7 percentage points (of which 1.3 percentage points were accounted for by transportation and communication).
0
2
4
6
8
10
12
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Headline Inflation Core Inflation
Headline and Core Inflation Quarterly average in percent (2000=100)
Meanwhile, underlying inflation has been on an easing trend since 2005, with the exception of the mild rise in core inflation in the previous quarter, suggesting limited demand-based price pressures on overall inflation. Core inflation eased to 6.1 percent in the first quarter from 6.2 percent in the previous quarter. This was 1.4 percentage points lower than the 7.5 percent core inflation in the same quarter a year ago.
Likewise, alternative measures of core inflation (trimmed mean, weighted median and net of volatile items) estimated by the BSP decelerated in the second quarter. These were also lower compared to their rates in the comparable quarter a year ago.
With limited demand price pressures, core inflation likewise decelerates.
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To see whether pressures on consumer prices were becoming generalized, the distribution of price changes in the CPI basket was examined. This involved determining the proportion of CPI basket components (at the 4-digit level) showing inflation rates above a given threshold—in this case the midpoint of the 4.0-5.0 target for 2006—and finding out whether that proportion has been increasing or declining. As expected with lower inflation, the number of items with inflation rates greater than the threshold of 4.5 percent declined to 76 in the second quarter from 79 in the first quarter. These 76 items accounted for 44.8 percent of the CPI basket and contributed 4.6 percentage points to the total inflation. Further analysis was done by dividing the CPI into food and non-food components. The number of food items with inflation rates above threshold fell to 37 in the second quarter from 39 a quarter ago, while that of non-food commodities declined to 39 from 40.
The number of items with inflation rates above the threshold declines.
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Food Prices The slower price increases for rice, cereal preparation, dairy products, meat and tobacco pushed down food inflation during the quarter, offsetting the higher inflation for corn, eggs, fruits and vegetables, miscellaneous food items and beverages. Meanwhile, inflation for fish was steady during the quarter. The easing in food inflation was due largely to favorable agricultural production. Palay production, for example, grew by 6.9 percent in the January-March 2006 period, a turnaround from last year’s 1.5 percent contraction owing to the expansion in harvest area and increased use of quality seeds.1 Similarly, there were observed improvements in livestock production which contributed to slower inflation for dairy products and meat. On the other hand, the seasonal increases in the demand for certain food items such as cooking oil, common spices and seasonings and beverages during the May fiesta month contributed to the rise in the second quarter inflation of miscellaneous food items. Meanwhile, the typhoon which hit Southern Tagalog and Visayas areas in May contributed to the rise in the inflation of fruits and vegetables. Going forward, food prices are expected to remain favorable given expectations of good harvest conditions. The end of the La Niña weather disturbance and forecast of normal weather conditions should continue to augur well for agricultural production. This provides an assurance of adequate water supply for both rain-fed and irrigated farms. In addition, continued technical support to farmers by the government should help boost productivity during the period.
1 Bureau of Agricultural Statistics, Performance of Philippine Agriculture, January-March 2006, available online at
http://www.bas.gov.ph/perfperiod.php
Food inflation declines due to robust farm production.
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Non-Food Prices Non-food items, notably housing and repairs, fuel, light and water (FLW), services and miscellaneous items posted slower price changes in the review quarter relative to the previous quarter. In contrast, inflation for clothing was unchanged. Movements in oil prices continued to drive non-food price developments. Inflation for energy-related components of the CPI basket, specifically FLW and transportation and communication services (which include oil, gasoline and diesel) remained at double-digit levels despite observed easing.
5
15
25
35
45
55
65
75
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Dubai Crude Oil Quarterly average spot price in US dollars per barrel
Energy Prices International oil prices continued to rise in the second quarter with the average price per barrel of Dubai crude oil increasing by 11.8 percent to US$64.79 per barrel from the previous quarter’s average. Given limited surplus production capacity, world oil prices tended to be influenced by news on geopolitical uncertainties that suggested potential supply disruptions. For example, tensions over Iran’s nuclear program and the ongoing militant unrest in Nigeria pushed spot prices higher during the period. Production problems in US refineries and the onset of the hurricane season in the US Gulf also contributed to upward price pressures.
Non-food inflation is lower during the review quarter.
International oil prices continue to rise due to geopolitical uncertainties.
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as of 31-Dec-05
as of 31-Mar-06
as of 30-Jun-06
10
20
30
40
50
60
70
80
2000 2001 2002 2003 2004 2005 2006 2007
Spot and Estimated Future Prices of Dubai Crude Oil* Price in US dollars per barrel
*Futures price derived using Brent crude futures data.
Estimates of the futures price of Dubai crude derived from Brent crude futures data continue to indicate possible further increases in oil prices. In the near term, the current high oil price environment is likely to be sustained given tight demand-supply conditions in the international oil market. Despite some easing due to high prices and mild weather conditions, world oil consumption demand remains relatively strong. Steady demand for oil against a backdrop of limited increases in world spare oil production capacity and continuing risks of geopolitical uncertainty are likely to prevent any significant decline in international oil prices, moving forward.
6
11
16
21
26
31
36
41
46
1998 1999 2000 2001 2002 2003 2004 2005 2006
Premium Gasoline Diesel Oil
Local Retail Prices of Selected Oil Products Price in pesos per liter
In the domestic market, prices of most petroleum products were raised almost every week during the second quarter to reflect the increases in world crude prices. However, the local pump price of diesel was reduced once on 13-14 June 2006 owing to the one percent duty reduction following the implementation of Executive Order (EO) 527 during the month. Meanwhile, liquefied petroleum gas (LPG) prices were reduced thrice in April and raised four times in May. With the exception of LPG, the pump prices of petroleum products were generally higher as of 25 June 2006 compared to the end of the previous quarter. Relative to their end-December 2005 levels, the prices of gasoline and diesel at the end of the second quarter were higher by 19.2 percent and 17.5 percent, respectively. These increases were smaller than those for the benchmark Dubai crude oil price during the same period as local oil companies were constrained from sharply increasing their prices by competition and weak demand. On the other hand, prices of LPG were lower by about 8.1 percent compared to end-December 2005 levels.
Meanwhile, domestic inventories of oil fell during the quarter. Total inventories were at an equivalent of 57 days of supply as of 19 June, lower than the inventory level of 70 days of supply on 27 March.
Local oil companies raise domestic pump prices to reflect the increase in world energy prices.
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The industry’s oil inventory includes an equivalent of 33 days of finished products, which is more than twice the Government’s required minimum inventory level of 7 to 15 days. Meanwhile, the inventory of crude in stock and crude in transit amounted to 10 days and 14 days of supply, respectively.
Utility Charges On the other hand, transmission charges are expected to rise starting October 2006. The Energy Regulatory Commission (ERC) is set to approve the proposed increase in the revenue ceiling of the National Transmission Corporation (TRANSCO) wherein the new Maximum Allowable Revenue (MAR) could result to higher rates (in Luzon, Visayas and Mindanao grids) charged by TRANSCO. The updated MAR will cover the period October 2006 until December 2006. In October 2006, the TRANSCO will submit to ERC its report on the rate adjustments process which will become the basis for setting the MAR for 2007.
Transmission charges are set to rise.
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Meanwhile, the commercial operation of the Wholesale Electricity Spot Market (WESM) in Luzon will begin in July 2006. The ERC will conclude the evaluation on the Philippine Electricity Market Corporation’s (PEMC) application for the approval of the structure and level of market fees for the WESM by June 2006 following a series of hearings in May 2006.2 The ERC needs to approve the following: (1) price determination methodology; (2) market fees to be charged to all WESM members; and (3) the administered price cap. Energy officials are of the view that there is little room for price reductions in the near term once the WESM becomes operational, since 90 percent of the capacity of power generators are still covered by bilateral contracts which provide for fixed prices. However, over the longer term, the competition in the market is expected to weed out the inefficient producers and should keep both contract and spot market prices low.3
Aggregate Demand and Supply
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-2
0
2
4
6
8
10
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
GDP GNP
GDP and GNP Growth Rates Annual Growth in Real Terms
Growth in real Gross Domestic Product (GDP) accelerated to 5.5 percent, based on the latest available data as of the first quarter of 2006. This can be traced to the solid performance of the industry and services sectors and the recovery in agricultural output. Economic growth was also underpinned by strong exports and resilient consumer spending. Meanwhile, the country’s Gross National Product (GNP) rose by 5.8 percent in the first quarter with the sustained growth in Net Factor Income from Abroad (NFIA), consisting mainly of remittances from OFWs.
2 ERC, WESM pricing scheme ready by June – ERC, 6 June 2006, available online at http://www.erc.gov.ph 3 WESM, WESM Frequently Asked Questions, available online at http://www.wesm.ph/general.faqs/#19
Economic growth accelerates in the first quarter of 2006.
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-25-20-15-10
-505
1015202530
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Govt. Spending Private ConsumptionFixed Investment
Domestic Demand Annual Growth in Real Terms
Aggregate Demand Expenditures by major economic sector Personal consumption expenditure (PCE) grew slightly faster by 5.1 percent during the first quarter of 2006 relative to both the previous year and previous quarter. Higher growth rates were observed for expenditures on food, beverage, fuel, light and water, household operations, and miscellaneous items. Expenditures on transportation and communication increased at a slower but still strong pace of 14.1 percent from 17.5 percent in the previous year. Increased public sector spending on the back of improving fiscal position drove government consumption expenditure higher during the first quarter. Meanwhile, investments in fixed capital remained weak, resulting mainly from the decline in durable equipment investments. The national income accounts (NIA) data also showed weak growth of 0.6 percent in total imports during the first quarter. The decreases posted by six of the 15 principal merchandise imports pulled down the growth in total merchandise imports to 0.2 percent. Meanwhile, imports of non-factor services registered an 8.2 percent growth.
The latest trade data from the NSO show that growth in merchandise imports (in terms of US dollars) decelerated to 7.4 percent in April from 8.0 percent in March. This was due to lower imports of mineral fuels, lubricants and related materials; consumer goods; and goods classified under special transactions. Imports of electronic products, which comprised 50.5 percent of the total import bill in April, registered a faster growth of 16.9 percent compared to 3.6 percent in March. On a month-on-month basis, growth in merchandise imports slowed to 6.8 percent in April from 23.2 percent in the previous month.
Personal consumption expenditure remains the key driver of aggregate demand.
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50
55
60
65
70
75
80
85
90
95
100
2000 2001 2002 2003 2004 2005 2006
Average Capacity Utilization for Manufacturing In percent
Other Demand Indicators Latest available data show improvements in selected demand indicators. Manufacturing activity expanded albeit at a slower pace, residential and office vacancy rates declined, vehicle sales picked up, and consumer and business confidence improved. On the other hand, energy sales decelerated while appliance sales continued to fall. • Average capacity utilization in manufacturing
in April was unchanged from March at 80.1 percent. About 58.6 percent of the manufacturing firms in the sample were operating at 70-89 percent capacity in April while only 9.7 percent were at full or near-full capacity operation (90-100 percent).
-20
-10
0
10
20
30
1999 2000 2001 2002 2003 2004 2005 2006
Volume of Production Value of Production
Growth in Volume and Value Indices of Manufacturing Production Year-on-year change in percent
• Based on the NSO’s Monthly Integrated Survey of Selected Industries (MISSI)— which covers 509 establishments—growth in manufacturing activity slowed in April. The value of production index (VAPI) for the manufacturing industry increased by 3.0 percent year-on-year and 2.0 percent month-on-month. Meanwhile, the volume of production index (VOPI) fell for the fourth straight month in April. On a month-on-month basis, VOPI rose slightly by 1.4 percent from 2.4 percent in the previous month.
-100
-50
0
50
100
150
200
2003 2004 2005 2006-60
-10
40
90
140
Car Sales Trucks and Buses Sales
Sales of Passenger Cars and Trucks and Buses Annual Growth in percent
Car Sales Trucks and Buses
• Passenger car sales increased by 22.1 percent year-on-year in May, based on data from the Chamber of Automotive Manufacturers of the Philippines, Inc. (CAMPI). On a month-on-month basis, passenger car sales rose by 35.5 percent, following a drop of 14.3 percent in April. On a seasonally-adjusted basis, the volume of car sales rose by 23.0 percent in May from 5.1 percent in April.
Other demand indicators generally show improving demand conditions.
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• Meanwhile, sales of trucks and buses rose
by 40.8 percent year-on-year in May. On a month-on-month basis, sales of trucks and buses increased by 43.2 percent in May from a decline of 23.9 percent in the previous month. Similarly, seasonally-adjusted sales of trucks and buses increased 31.6 percent, following an 11.3 percent drop in April. According to the CAMPI and the Truck Manufacturers Association (TMA), the month-on-month pickup in vehicle sales was due to intensive marketing promos, the release of new models, and fleet deliveries.
-10
-5
0
5
10
15
2000 2001 2002 2003 2004 2005 2006
Meralco Power Sales Annual Growth in percent
• Growth in total energy sales by the Manila Electric Company (Meralco) slowed to 1.1 percent year-on-year in April, due to lower growth in consumption by the commercial and industrial sectors and the decline in consumption by residential users. On a month-on-month basis, energy sales rose at a faster pace of 4.0 percent in April compared to 0.6 percent in March. However, seasonally-adjusted energy sales fell by 3.1 percent in April following an increase of 1.5 percent in the previous month.
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-50
-40
-30
-20
-10
0
10
20
30
40
2000 2001 2002 2003 2004 2005 2006
Appliance Sales Annual Growth in percent
• Appliance sales continued to decline, with volume falling by 19.2 percent in April 2006. On a month-on-month basis, appliance sales posted a 5.0 percent increase, lower than the previous month’s 20.7 percent. However, on a seasonally-adjusted basis, appliance sales declined by 2.6 percent from an uptick of 0.8 percent in the previous month.
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• Based on estimates of Colliers International Research, property values in the Makati Central Business District (CBD) and Ortigas Center increased during the first quarter of 2006. The average office and residential vacancy rates in the Makati CBD eased during the same period.
• The BSP’s Business Expectations Survey (BES) showed a more optimistic outlook for the second and third quarters of 2006. Respondent firms attributed their optimism to expectations of the following: (1) increased consumer spending due to the opening of the school year in June; (2) continued stability of the peso; (3) stronger export receipts; and (4) better investment opportunities. The business outlook is expected to improve further in the third quarter of 2006 as shown by the higher Diffusion Index of 32.8 percent.
• Results of the latest Consumer Expectations Survey (CES) showed improving consumer outlook for the second and third quarters of 2006, as well as for the next 12 months. Respondents attributed this to the following: 1) expected increase in income arising from better business conditions; 2) expectations of more family members working; 3) higher family savings; and 4) expected decrease in prices of goods. While the overall CE index remained negative for the second and third quarters, the one-year-ahead CE index had reversed to 3.6 percent from -7.7 percent in the previous survey.
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External Demand Real export growth, as reported in the NIA data, accelerated to 12.2 percent as both merchandise exports and exports of non-factor services posted double-digit growth during the first quarter.
The latest trade data from the NSO showed that growth in merchandise export earnings (in terms of US dollars) slowed to 18.7 percent year-on-year in April, due to lower growth in exports of manufactured goods. On a month-on-month basis, merchandise export receipts dropped 6.7 percent, a reversal of the 19.7 percent expansion in March.
Aggregate Supply
-15.0
-10.0
-5.0
0.0
5.0
10.0
15.0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Agriculture Industry Service
Agriculture, Industry and Service SectorsAnnual Growth in Real Terms
Output growth during the first quarter of 2006 was driven by the sustained growth in services, the faster increase in industry output, and the recovery in agricultural production. Despite the deceleration in nearly all its sub-sectors, services grew by a solid 6.2 percent and accounted for more than half of GDP growth. Driving the sector were trade and finance, which in turn, were boosted by higher sales of pharmaceutical products, petroleum products and supermarket goods, and higher interest and non-interest income of banks. Growth in communications remained strong at 13.1 percent, as did growth in business services at 8.7 percent, which was underpinned by the sustained expansion of call centers and the business process outsourcing (BPO) ventures.
Exports post double-digit growth.
Sustained growth in industry and services, as well as the upturn in agriculture, boost economic output.
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The agriculture, fishery and forestry (AFF) sector staged a recovery in the first quarter, as a result of improvements in the production of corn, palay, fishery and banana. Favorable weather conditions, expansion in yields and harvest area, and government programs to raise farm productivity boosted crop production. Higher prices and the increase in the country’s export quota to the US led to an upturn in sugarcane production. Meanwhile, higher demand for banana exports resulted in the expansion of banana plantations in several regions, while aquaculture continued to lead the growth in fishery output. Growth in the industry sector accelerated as all sub-sectors registered higher growth during the first quarter. In particular, manufacturing, which is the biggest contributor to domestic output, grew by 6.0 percent from 4.9 percent, with gains posted in food, electrical machinery, textiles and basic metals. Higher electricity demand from information technology-related industries, malls and the Light Rail Transit (LRT) operations, and the increased coverage and efficiency of water distribution supported the electricity, gas and water (EGW) sub-sector. Meanwhile, mining expanded modestly during the first quarter.
Based on latest government projections, GDP will likely grow by 5.5-6.2 percent in 2006, on expectations of sustained growth in services, improvements in agricultural production, and resilient consumer spending. Downside risks to growth include the increases in oil prices, the volatility of global financial markets, and the potential adverse impact on consumption of higher commodity prices.
Aggregate demand is likely to remain driven by personal consumption spending, as investments in fixed capital have remained weak.
GDP is expected to grow between 5.5-6.2 percent in 2006.
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The services sector is expected to be driven by communications and finance, with the brisk expansion in mobile phone services, call centers and BPOs, and further consolidation and improvement in asset quality of banks. Industry is expected to be boosted by the steady growth in manufacturing and construction, while prospects for agriculture are favorable given expectations of normal weather conditions and increases in yields and harvest area.
Labor Market Conditions
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7
8
9
10
11
12
13
14
15
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Unemployment Rate*
* Based on the old LFS definition
Despite lower unemployment rates due to gains in the agriculture and services sectors, labor market conditions generally remained soft as unemployment stayed at double digits using the old definition. Based on the latest Labor Force Survey (LFS) conducted by the NSO last April 2006, the jobless rate declined to 11.8 percent in April 2006 from 12.7 percent a year ago but rose from 10.7 percent in January 2006.4 Similarly, using the new definition, the unemployment rate declined in April 2006 to 8.2 percent from 8.3 percent in April 2005, but increased slightly from 8.1 percent in January 2006.5 The total number of employed persons grew by 2.5 percent, led largely by the agriculture, as well as the services sector. Employment in the agriculture sector rose by 3.9 percent (or 362,000 workers), while services recorded a 2.4 percent increase in employment. Meanwhile, employment in the industry sector remained at 5.24 million workers, as jobs lost in construction and manufacturing were compensated for by the mining and quarrying as well as the utilities subsectors.
4 Starting April 2005, the new LFS questionnaire defines the unemployed to “include all persons who were 15 years old
and over as of their last birthday and were reported as (1) without work; and (2) currently available for work; and (3) seeking work or not seeking work due to valid reasons”.
5 The old definition did not consider the availability criterion.
Overall labor market conditions remain generally soft as the jobless rate remains at double digits.
18
The National Capital Region (NCR) Wage Board approved on 25 June 2006 a P25 (7.7 percent) increase in minimum wages in the private sector effective on 11 July 2006. The wage hike brings the daily minimum wage in Metro Manila to P350 for nonagricultural workers and to P313 in the case of agricultural workers and those in smaller hospitals and service and manufacturing establishments. Meanwhile, wage boards in other regions are expected to follow suit, as remaining deliberations and final hearings were set to be finished by mid-July.
II. MONETARY AND FINANCIAL CONDITIONS
Interest Rates
2
4
6
8
10
12
14
16
18
20
2000 2001 2002 2003 2004 2005 2006
91-day T-bill rate Overnight RRP RateBank Lending Rate (Low-end)
91-day T-bill, BSP RRP rate and KBs Lending Rate In percent
Domestic interest rates were on a general uptrend during the quarter. From 5.0 percent in March, the bellwether 91-day T-bill rate initially eased to 4.7 percent in April before rising slightly to 4.8 percent in May. During the 26 June primary auction, the Auction Committee allowed the 91-day T-bill rate to rise to 6.5 percent, following the cancellation of the 29 May auction and the full rejection of bids at the 13 June auction. The 91-day T-bill rate averaged 5.2 percent in the second quarter, higher than the 5.0 percent average in the previous quarter. The range of bank lending rates also rose during the quarter. Average bank lending rates increased to 8.6-10.3 percent in June from 8.2-9.9 percent in March.
Domestic interest rates inch up during the quarter.
NCR Wage Board approves a P25 increase in minimum wage.
19
5
6
7
8
9
10
11
12
13
3Mo 6Mo 1Yr 2Yr 3 Yr 4Yr 5Yr 7Yr 10Yr 20Yr 25YrMaturity
Yiel
d in
per
cent
Dec 2005 Mar 2006Jun 2006
Yield of Government Securities in Secondary Market In percent
.
Yield Curve Secondary market yields for government securities were higher in June compared to March. Secondary market yields have started to rise beginning in the third week of May as market sentiment weakened due to uncertainties relating to the National Government’s cash position and the possibility of further hikes in US interest rates.
0
2
4
6
8
10
12
14
16
BSP RRP rate US Fed funds rate
BSP RRP Rate and US Fed Funds Rate In percent
2001 2002 2003 2004 2005
Interest Rate Differentials Spreads between Philippine and US interest rates generally widened. The differential between the benchmark 91-day T-bill rate (gross of withholding tax on interest income) and the US 90-day LIBOR and the US 90-day T-bill rate widened to 111.5 basis points and 155.0 basis points, respectively in June 2006 from 7.8 basis points and 22.0 basis points in March 2006. Meanwhile, the after-tax spreads between the domestic 91-day T-bill rate and the US 90-day T-bill rate turned positive to 25.0 basis points in June 2006 from -78.0 basis points in March 2006. On the other hand, the net-of-tax differential between the Philippine 91-day T-bill rate and the US 90-day LIBOR narrowed but remained negative at -18.5 basis points in June 2006 from -92.2 basis points in March 2006. The differential between the BSP’s policy interest rate (overnight borrowing or RRP rate) and the US federal funds target rate narrowed to 225 basis points in June 2006 from 275 basis points in March due to the cumulative 50 basis points increase in the US policy rate during the second quarter.
Secondary market yield curve shifts upward.
Following the rise in nominal T-bill rates, spreads between local and US market rates widen.
20
Adjusted for the risk premium—as measured by the differential between the 10-year ROP note and the 10-year US Treasury note—the differential between the BSP’s policy rate and the US federal funds target rate narrowed to 28 basis points as of end-June 2006 compared to 166 basis points in end-March 2006.
0.5
1.3
2.1
2.5
2.8
3.3
5.8
5.9
5.6
4.2
0 2 4 6 8
Indonesia
Thailand
Japan
Malaysia
Philippines
South Korea
Singapore
India
Taiwan
Hong Kong
Average Real Lending Rates: Selected Asian Countries In percent
Real Lending Rate The real lending rate—measured as the difference between the median bank lending rate and inflation—edged higher in the first quarter, rising to 2.8 percent in June from 1.5 percent in March. Among a sample of 10 Asian countries, the Philippines’ real lending ranked fifth lowest.
1.47
2.45
2.50
2.74
2.96
3.20
3.74
4.20
5.04
5.26
0 1 2 3 4 5 6
South Korea
Japan
Singapore
Thailand
Philippines
Malaysia
Indonesia
Hong Kong
Taiwan
India
Spread of Lending Rates over Benchmark Rates In percent
Meanwhile, the spread between the Philippine lending rate and the 91-day T-bill rate narrowed to 296.4 basis points in June from 413.8 basis points in March due to the sharp increase in the 91-day T-bill rate. Across the region, the Philippines’ spread was within midrange compared to those registered in other economies.
The real lending rate edges higher during the quarter.
21
Financial Market Conditions
Appetite for local equities and government debt papers remained strong in the second quarter indicating the continued presence of ample liquidity in the market amid low supply of government securities.
500
1,000
1,500
2,000
2,500
3,000
2000 2001 2002 2003 2004 2005 2006
PSE Composite Index
Stock Market Trading continued to be robust in the local stock market with the Philippine Stock Exchange Composite Index (PSEi) staying consistently well above the 2,000–level during the second quarter.6 From an average PSEi of 2,126.4 index points in the first quarter, the PSEi moved up to an average of 2,229.7 index points in April as market players positioned themselves behind stocks that were likely to report strong market results. Share prices extended gains in May with the PSEi rising to its highest monthly average of 2,384.8 index points for the first semester. The bullish sentiment in May was supported by favorable first quarter data on output, improvements in the fiscal position as well as the monetary authorities’ decision to keep policy rates unchanged. In June, however, investors opted to stay on the sidelines amid global jitters of higher interest rates. Furthermore, the slowdown in OFW remittances dampened market sentiment. The average PSEi was 2,147.3 in June, lower than the averages posted in April and May but was still higher than the average PSEi in the first quarter.
6 The PSEi replaced PHISIX beginning 14 March 2006.
Demand for equities and government securities remain strong.
Sentiment remains relatively upbeat in local equities market.
22
Going forward, some factors may limit gains in the equities market. These include expectations of further increase in the US Fed’s policy interest rates and the possibility that the political environment could heat up again with the likely resurfacing of an impeachment case against the President.
0
50
100
150
200
250
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Oversubscription of Primary T-bill Auction In billion pesos
Government Securities Primary auctions of T-bills by the Bureau of the Treasury (BTr) continued to attract an excess of tenders in the second quarter, indicating the presence of ample liquidity in the system and reinforced by the market’s positive fiscal outlook. Given the healthy cash position of the National Government, the BTr decided that auctions be held every two weeks. The banks’ high bid rates were partially rejected in May as the BTr accepted only 70 percent of the P6.0 billion offering for the month. Further, it rejected all bids during the 13 June 2006 auction. Total oversubscriptions for the quarter amounted to around P68.3 billion, lower than the P126.9 billion posted in the previous quarter. This resulted as the seven T-bill auctions in the second quarter drew a total of P89.3 billion tenders as against the P21 billion aggregate offering. The average over subscription in the second quarter amounting to P9.8 billion is lower than the previous quarter’s average of P11.1 billion. Meanwhile, total rejections for the period amounted to P72.3 billion, or around P10.3 billion per auction.
Banking System
The Philippine banking system remained stable and fundamentally sound during the second quarter of the year. While bank lending activity remained subdued and asset growth posted minor gains, banks managed to register modest growth in deposits and capital accounts. These gains were notably achieved against the
Ample liquidity continues to fuel demand for government debt papers.
The banking system remains generally sound.
23
backdrop of increased sophistication of the financial services industry and the continued alignment of local banking practices with international standards.
Savings Mobilization The banking system’s deposit liabilities eased moderately by about 0.1 percent as of end-April 2006 compared to the end-March 2006 level but posted higher growth of 4.9 percent compared to the same period last year. Demand deposit, which comprised the smallest share of 14.3 percent of the total deposit liabilities, grew by 2.2 percent during the period under review compared to the previous month while time deposit contracted by 2.0 percent. Savings deposit, which expanded slightly by 0.5 percent, continued to account for more than half of the banks’ funding base.
-6
-4
-2
0
2
4
6
8
10
2000 2001 2002 2003 2004 2005 2006
Total Loans Outstanding of Commercial Banks Year-on-year change in percent
Lending Operations Commercial bank (KB) loans picked up by 1.3 percent year-on-year to P1.6 trillion as of end-April 2006. This was a turnaround from the 0.5 percent year-on-year decline recorded in the previous month. On a month-on-month basis, KB loans grew by 1.3 percent in April, an upturn from the 1.6 percent decline in the previous month. The modest improvement was driven mainly by loans to the Financial Institutions, Real Estate and Business Services (FIREBS) sector, which recorded a 14.0 percent year-on-year increase during the month; the Agriculture, Fisheries and Forestry sector, which expanded by 8.0 percent; and the Community, Social and Personal Services sector which grew by 3.3 percent. However, increases in lending to these sectors were offset by notable declines in other key sectors such as Construction (33.2 percent); Wholesale and Retail Trade (12.2 percent); and Transportation, Storage and Communication (9.3 percent).
Deposit liabilities of the banking system ease moderately.
Growth in commercial bank loans remains modest.
24
Meanwhile, the KBs’ credit card receivables (CCRs) as of end March 2006 declined by 4.8 percent to P76.0 billion from the end December 2005 level of P79.9 billion. The ratio of CCRs to total loan portfolio remained steady at 3.7 percent. KBs’ past due accounts stood at 20.5 percent of total CCRs from the 19.8 percent recorded a quarter ago. On the other hand, total auto loans were up by 3.6 percent to P57.9 billion as of end March 2006 from the end December 2005 level of P55.9 billion. As a ratio to total loan portfolio, auto loans stood at 2.8 percent. Only 4.0 percent of total auto loans were past due.
Institutional Developments The total resources of the banking system fell slightly by 0.4 percent from the previous month to P4.42 trillion as of April 2006. Compared to the previous year, however, this was 1.0 percent higher due mainly to the increase in the banks’ deposits with the BSP, loans and discounts, and cash holdings. Commercial banks accounted for the bulk of the total resources of the banking system with an almost 90 percent share.
The ongoing restructuring of the banking system, which involves consolidation and closure of weak banks, further reduced the number of banking institutions from 879 at end December 2005 to 872 as of end March 2006. The total number of banking institutions comprised of 41 KBs, 85 thrift banks and 746 rural banks. However, the operating network of the banking system increased to 7,672 as of end March 2006 from 7,670 at end December 2005 reflecting partly the increase in rural banks’ branches/agencies.
Resources of the banking system decline slightly in April 2006.
Consolidation and closure of weak banks reduce the number of banking institutions.
25
The banks’ portfolio of non-performing assets increased slightly but remained at a single-digit level as the non-performing loans (NPL) ratio to total loan portfolio inched up to 8.9 percent as of April 2006 from the previous month’s ratio of 8.7 percent. The increase in the ratio during the month was mainly due to the 1.6 percent decline in total loan portfolio combined with the rise in the level of NPLs by 0.8 percent.
6
8
10
12
14
16
18
20
2000 2001 2002 2003 2004 2005 2006
Non-Performing Loans of Commercial Banks Percentage of Total Commercial Bank Loans
Meanwhile, universal and commercial banks (U/KBs) managed to maintain the industry’s NPL ratio at a single-digit level (8.24 percent as of end April 2006) for nearly a year now. Although this month’s ratio stood higher than the end March 2006 ratio of 8.01 percent, it was lower by 3.00 percentage points compared to the 11.24 percent posted a year ago.
Compared to those of other countries in the region, the Philippines’ NPL ratio was close to Thailand’s 8.2 percent and Indonesia’s 8.3 percent. This was, however, higher than Korea’s 1.1 percent and Malaysia’s 5.9 percent.7 The lower NPL ratio in other Asian countries may be traced to the publicly-owned asset management companies’ (AMC) purchases of the bulk of their NPLs.
The loan exposure of banks remained adequately covered as the banking system’s NPL coverage ratio remained steady at 71.3 percent as of end April 2006, reflecting the banks’ diligent compliance with the loan-loss provisioning requirements of the BSP as buffer against unexpected losses.
7 Source: ARIC Financial Indicators, ADB website. Financial system’s NPL, Thailand (February 2006); Malaysia
(February 2006); Korea (KBs, December 2005); and Indonesia (December 2005).
Banks’ NPL ratio increases slightly.
26
Using the new risk-based framework, the KBs remained adequately capitalized as of end September 2005, with the industry’s capital adequacy ratio (CAR) at 16.7 percent on a solo basis and 17.6 percent on a consolidated basis. The industry’s CAR continued to exceed the statutory level set by the BSP at 10.0 percent and the Bank for International Settlements’ (BIS) standard of 8.0 percent. This is reflective of the banking system's improved ability to cover risky assets.
The Philippines’ CAR remained comparatively higher than that of Malaysia (13.1 percent), Thailand (13.98 percent) and Korea (12.4 percent)8, but lower than that of Indonesia which posted the highest CAR in the region at 19.6 percent as of November 2005.
The total volume of banks’ placements with the BSP under the RRP window amounted to P170.9 billion as of end June 2006, lower by P6.4 billion from the end-March 2006 level. The banks’ excess funds continued to be placed with the BSP under the RRP facility as the growth in bank lending remained relatively modest and the supply of government securities limited.
8 Source: ARIC Financial Indicators, ADB website. Commercial banks CAR: Malaysia (February 2006); Thailand
(February 2006); and Korea (December 2005).
Capital adequacy ratio is higher than the statutory level set by the BSP and the BIS.
The banks’ placements under the BSP’s RRP facility decline.
27
Exchange Rate
35
40
45
50
55
60
2000 2001 2002 2003 2004 2005 2006
P/US$
Daily Peso-US Dollar Rate
The peso weakened during the second quarter of 2006 averaging P52.29/US$1 compared to the previous quarter’s average of P51.85/US$1. On a year-to-date basis, the peso depreciated by 0.05 percent against the US dollar as of 30 June 2006.9 The peso weakened quite rapidly during the period as it slid down to the P52 level by mid- May from an average of P51.39/US$1 in April. It further dropped to P53.59/US$1 on 29 June 2006, its weakest level for the year. The depreciation of the peso against the dollar negated the gains made during the first quarter of 2006. The recent volatility in capital flows in emerging and global financial markets, triggered by concerns over the possibility of stronger-than-expected inflationary pressures and interest rates in the US, sent the local currency plummeting to its lowest level in 2006. In the domestic front, renewed impeachment initiatives, and possible realignment of revenue targets among the revenue-generating agencies and its impact on the sustainability of the overall fiscal position also dragged the peso lower.
9 Dollar rates or reciprocal of the peso-dollar rates were used to compute for the percent changes.
The peso weakens against the dollar during the review period.
28
On a real, trade-weighted basis, the peso depreciated against the basket of currencies of the country’s major trading partners (MTPs) and against its competitor countries both in the broad and narrow series.10 The peso’s real effective exchange rate (REER) index depreciated relative to the currencies of its MTPs by 2.45 percent while for the broad and narrow series, REER depreciated by 1.83 percent and 2.41 percent, respectively. The peso’s nominal depreciation offset the impact of rising inflation differential across the three baskets which suggests that the peso maintains some competitiveness against these baskets.11
Nonetheless, the peso is expected to stabilize for the rest of the year despite the current volatility in the financial markets. The peso is likely to weather these external shocks given the country’s sound macroeconomic fundamentals—particularly the country’s resilient economic growth and improvement in the national government’s fiscal position. Sustained dollar inflows from overseas foreign workers’ remittances, portfolio and foreign direct investments as well as export receipts are expected to further prop up the currency. Foreign direct investments, specifically in export-related industries, are seen to improve markedly in 2006 due in part to continued positive investor sentiment.
10 The basket of the major trading partners is composed of the currencies of US, Japan, the Euro area and the United
Kingdom. The broad basket of competitor countries comprises the currencies of Singapore, South Korea, Taiwan, Malaysia, Thailand, Indonesia and Hong Kong while the narrow basket is composed of the currencies of Indonesia, Malaysia and Thailand only.
11 The REER index represents the Nominal Effective Exchange Rate (NEER) index of the peso, adjusted for inflation rate differentials with the countries whose currencies comprise the NEER index basket. The NEER index, meanwhile, represents the weighted average exchange rate of the peso vis-à-vis a basket of foreign currencies.
Strong macro fundamentals and sustained dollar inflows should provide support to the local currency.
The peso maintains external competitiveness on a real, trade-weighted basis.
29
Monetary Aggregates
Demand for money accelerated in the second quarter as M3 growth rose to 10.0 percent and 12.7 percent in April and May, respectively from 9.1 percent in March 2006.12 Growth in liquidity continued to be driven by inflows from OFW remittances and direct investments, allowing the BSP to build up its reserves and reduce its foreign liabilities. Meanwhile, the increase in deposit money banks’ (DMBs) net foreign asset position in May, which was due mainly to a reduction in their foreign liabilities, also supported the increase in liquidity. In addition, the growth in credits to the public sector, particularly credits to LGUs and other public entities in the form of loans and investments, contributed to the expansion in domestic liquidity.
Similarly, the year-on-year growth in reserve money, a narrower measure of liquidity, accelerated to an average of 15.6 percent in the second quarter from 9.1 percent in the previous quarter.13
Fiscal Developments
The National Government posted a P44.2 billion fiscal deficit for the period January to May 2006. This was 34.8 percent lower than the P67.8 billion deficit level incurred during the same period last year owing to better revenue collection performance and prudent spending.
12 M3 refers to the stock of broad money based on data on the DCS. The DCS, which replaces the Monetary Survey
(MS) as the basis for measuring domestic liquidity, features an expanded list of surveyed institutions that includes the BSP, commercial banks, thrift banks, rural banks, non-stock savings and loan associations and non-banks with quasi-banking functions.
13 Reserve money (RM) is a narrower definition of money supply defined as the sum of currency issue net of cash in vaults of the BTr and banks’ reserve balances with the BSP.
Growth in domestic liquidity accelerates.
Government is likely to keep deficit within target.
30
Revenue collections for the first five months of the year reached P389.8 billion, higher by 19.3 percent compared to P326.8 billion in the same period last year. The improved revenue collection performance for the period under review can be attributed to the double-digit growth of revenue collections by the Bureau of Internal Revenue (20.7 percent) and the Bureau of Customs (34.3 percent) compared to the same period in 2005. Meanwhile total disbursements amounted to P433.9 billion, 10 percent higher than the comparable disbursements in 2005 mainly on account of increased spending for subsidies, equity contributions and net lending to government owned and controlled corporations (GOCCs). Current developments in the fiscal sector indicate that the National Government could stay below the targeted full-year deficit affording it some elbow room to finance additional priority social services and infrastructure projects during the year.
31
III. External Developments
Global economic momentum continued to broaden on the renewed strength of domestic consumption and investment spending. The United States and China remained the main engines of global growth but Japan and the Euro area began to show clear signs of recovery. Sustained gains in employment conditions, favorable financial conditions and steady improvements in corporate profitability also underpinned global expansion. However, a number of uncertainties remain, notably the sustained volatility in international oil prices, continued deterioration in the global current account imbalance, and prospect of a considerable increase in global interest rates as monetary authorities proceed to further withdraw monetary stimulus. Risks to the outlook for price developments also remain on the upside. This relates mainly to further increases in oil and commodity prices and the growing resource utilization in many industrialized economies.
Global economic expansion broadens.
However, oil prices and other risk factors continue to pose a threat to the ongoing expansion.
32
The US economy bounced back in the first quarter of 2006 as the country’s real GDP growth accelerated to 5.3 percent year-on-year from 1.7 percent in the preceding quarter.14 A key uncertainty in the future course of the US economy, however, is the expected slowdown in consumption growth this year due to elevated energy prices and the foreseen softening of the housing market.15 The weaker than expected increase in non-farm payroll employment for May also signaled some moderation in economic activity. Latest price data, meanwhile, suggested heightened inflation pressures due largely to sustained increases in fuel prices. Year-on-year inflation rose considerably to 4.2 percent in May from 3.4 percent at the end of the first quarter while core inflation increased further to 2.4 percent from 2.1 percent in March. The US Federal Reserve notes that the cumulative increases in energy and commodity prices have been large enough that they could account for some of the recent pick up in core inflation.16
Euro area economic recovery gained momentum in early 2006. Real GDP increased by 0.6 percent from 0.3 percent in the fourth quarter of 2005. Growth was driven by the strong rebound of private consumption and exports while gross fixed capital formation remained moderate. Meanwhile, survey indicators for the industrial and services sectors point to a continued positive outlook for activity in the second quarter of the year. The European Commission’s confidence indicator and the Purchasing Managers’ Index (PMI) for both sectors sustained their uptrend in May.17
14 BEA News release no 06-17 entitled Gross Domestic Product: First Quarter 2006 (Advanced), 17 April 2006,
available online at http://www.bea.gov/bea/news 15 IMF, World Economic Outlook, April 2006 16 US Federal Reserve Board, Remarks by Chairman Ben S. Bernanke at the International Monetary Conference, 5
June 2006, available online at http://www.federalreserve.gov 17 ECB, Monthly Bulletin, June 2005, available online at http://www.ecb.int
US economic activity rebounds in the first quarter.
Euro area economic recovery benefits from strong private consumption.
33
The Euro-zone Harmonised Index of Consumer Prices (HICP) inflation edged up to 2.5 percent in May from 2.2 percent in March due to higher prices of transport fuels, gas and heating oil. The European Central Bank (ECB) expects the inflation rate to remain above 2.0 percent in the months ahead. While labor cost pressures have remained contained, the ECB notes that indirect effects of past oil price hikes and announced increases in indirect taxes are expected to have a significant effect on inflation developments. 18
Significant pick-up in industry output buoyed the UK’s real GDP growth to 0.6 percent in the first quarter, the same rate of expansion as in the previous quarter. Meanwhile, the growth in household spending decelerated during the quarter due largely to lower expenditure on both semi- and non-durable goods. Consumption spending, however, appeared to have recovered since then supported by steady improvements in housing market activity. Favourable economic conditions, low interest rates, and high levels of employment are expected to support the housing market over the remainder of 2006.19 Meanwhile, higher prices of gas, electricity, food and non-alcoholic beverages pushed the May CPI inflation rate to 2.2 percent from 1.8 percent in March. There had been a pick-up in the public’s inflation expectation since the turn of the year. However, the Bank of England (BOE) maintained that domestically generated inflation pressures remained weak as wage developments continued to be benign.20
18 Ibid 19 Halifax Research, Halifax House Price Index May 2006 National press release, 8 June 2006, available online at
http://www.hbosplc.com/economy/NationalPressRelease.asp 20 BOE, Minutes of the 7-8 June 2006 Monetary Policy Committee Meeting, 21 June 2006, available online at
http://www.bankofengland.co.uk
Strong industry output supports UK growth.
34
Firm domestic demand sustained Japanese economic recovery. The country’s real GDP expanded by 0.8 percent quarter-on-quarter following the 1.1 percent growth posted in the last quarter of 2005. Output growth was underpinned by the robust gains in personal spending and significant recovery in capital spending, backed by the continued improvements in corporate profitability. Industrial production also remained on an uptrend over the recent months backed by increases in exports and business investment, despite inventory adjustments in some areas.21 Private consumption is increasing moderately, reflecting improvements in consumer confidence and moderate gains in income. On the price front, the annual CPI inflation edged up to 0.4 percent in April from 0.3 percent in the previous month due to higher costs of petroleum products. The Cabinet Office is of the view that these developments suggest some improvement in the current trend of prices, although a situation of deflation may still remain.22
Emerging Asian economies continued to grow robustly in early 2006 on the renewed external demand for electronic products. This in turn stimulated growth in investment, employment and consumption in most economies. Rapid growth in fixed-asset investment and domestic consumption, along with robust exports and industrial production, buoyed China’s sustained economic expansion. Meanwhile, India’s real GDP growth for the 2005-2006 fiscal year was supported by significant recovery in agricultural production and sustained improvements in industrial activity and services output. However, persistent high oil prices present risks to the ongoing economic advancement in the region. Inflation has risen to double-digit levels in most ASEAN-4 countries due to fuel price increases, but second-round effects thus far have been modest.23
21 Japan Cabinet Office, Monthly Economic Report, June 2006, available online at http://www5.cao.go.jp/keizai3/
getsurei-e/2006jun.html 22 BOJ, Change in the Guideline for Money Market Operations, 9 March 2006, available online at http://www.boj.or.jp 23 IMF, Asia Pacific Regional Economic Outlook, May 2006
Gains in domestic demand buoy continued recovery of the Japanese economy.
Growth in emerging Asia remains strong owing mainly to healthy global demand for electronic products.
35
Monetary authorities in major central banks in the world continued to tighten their monetary policies. The US Federal Open Market Committee (FOMC) raised its target for the federal funds rate by 25 basis points in June to 5.25 percent, marking a cumulative rise of 425 basis points since June 2004.24 Similarly, the ECB raised the minimum bid rate of the main refinancing operations of the Eurosystem by 25 basis points to 2.75 percent to help ensure that medium to long-term inflation expectations in the Euro Area remain solidly anchored at levels consistent with price stability.25
Meanwhile, the BOE Monetary Policy Committee voted to keep its key repo rate at its current level of 4.50 percent during its 7-8 June 2006 meeting. The Committee noted that inflation remained close to target, but the balance of risks remains tilted to the upside in the near-term due to stronger import prices and declining spare capacity.26 The Bank of Japan (BOJ) also voted to maintain its uncollateralized overnight call rate at zero during its 14-15 June 2006 monetary policy meeting following the change in its operating target for money market operations in March.
24 Federal Reserve, FOMC Statement dated 29 June 2006, available online at http://www.federalreserve.gov/
boarddocs/ pres/ monetary/2006 25 ECB, Monthly Bulletin, June 2006, available online at http://www.ecb.int 26 BOE, Minutes of the 7-8 June 2006 Monetary Policy Committee Meeting, available online on
http://www.bankofengland.co.uk/monetarypolicy/decisions
Monetary policy guidelines are left unchangedby the BOE and BOJ.
The US and EU maintain their tightening stance.
36
IV. MONETARY POLICY DEVELOPMENTS
4
6
8
10
12
14
16
18
2000 2001 2002 2003 2004 2005 2006
BSP Policy Interest Rates In percent
Overnight Repurchase (RP) Rate
Overnight Reverse Repurchase (RRP) Rate
During the quarter in review, the Monetary Board met four times and left the BSP’s key policy rates unchanged. The overnight RRP rate or borrowing rate remained at 7.5 percent while the overnight RP rate or lending rate was maintained at 9.75 percent. Policy interest rates were last changed on 20 October 2005.
The Monetary Board kept policy rates steady during the quarter as available evidence on current and expected inflation continued to paint a manageable inflation outlook over the policy horizon. The BSP’s projected inflation path continued to suggest a deceleration beginning in the second half of 2006, while average inflation for 2007 is expected to hit the 4-5 percent target in the absence of further adverse shocks. Inflation expectations also appear to be well-contained, judging from the results of the BSP’s surveys among private sector economists and households. Likewise, the Monetary Board noted that indications of stable core inflation, soft demand conditions and a relative absence of second-round effects supported the case for keeping policy rates unchanged.
BSP keeps its policy rates unchanged.
Assessment of available economic data and forecasts supports case for keeping policy rates steady.
37
However, the Monetary Board recognized that the outlook for inflation was still accompanied by risks. Movements in oil prices would remain a key driver in the inflation process. As a major input to production and transport, oil prices are expected to continue to influence domestic inflation. At the same time, expected adjustments in domestic power costs could lead to a continuing environment of supply-side pressures. Such a scenario could increase the risk of an adverse shift in the public’s inflation expectations as well as second-round effects in wage- and price-setting. Rising global interest rates will also have to be closely monitored, in view of their impact on capital movements and inflation.
The monetary authorities likewise noted that second-round effects in the form of wage increases would still remain a possibility given the pending applications for wage increases in the regional wage boards. A P25 wage increase had already been approved in Metro Manila, roughly in line with the BSP’s wage increase assumption of P26. Past data suggest that the NCR wage increase could serve as a ceiling on increases in other regions.
Going forward, the Monetary Board is of the view that its key policy priority remains that of managing the risks to inflation expectations and the risk of potential second-round effects on wage- and price-setting. At the same time, the Monetary Board will continue to strengthen its support for non-monetary measures by concerned government agencies given that existing price pressures remain on the supply-side.
The main policy priority is to manage risks to inflation expectations and potential second-round effects.
Monetary authorities recognize that there are risks to the inflation outlook.
38
Box: Changes in the Operating Procedures of Inflation Targeting In line with the continuing efforts to further strengthen the BSP’s inflation targeting (IT) framework, the BSP has commissioned the services of three international experts for the project: “Review of the BSP’s Inflation Forecasting Models and Operating Procedures Under the Inflation Targeting Framework”.1 The results of these independent studies along with the recommendations of the BSP staff based on these studies were presented to and reviewed by the Monetary Board. On 18 May 2006, several proposed changes in the operational procedures in the implementation of IT were approved by the Monetary Board which included the following: (a) reduction in the frequency of meetings of the Monetary Board on monetary policy issues to every six weeks from every four weeks; and (b) reduction in the lag in the publication of the highlights of the Monetary Board meetings on monetary policy issues to four weeks from six weeks. The new schedule of Monetary Board meetings and publication of the highlights of the meetings of the Monetary Board on monetary policy issues are available on page iv of this report and are likewise posted on the BSP website. These adjustments will start in July 2006. Reduced frequency of policy meetings The shift from a four-week to six-week interval for policy meeting will allow the Monetary Board to consider a larger amount of macroeconomic data in its policy discussions and also have more time for analysis and evaluation of the economic evidence. This does not, however, preclude the convening of special meetings of the Monetary Board, whenever warranted. The decision of the Monetary Board to reduce the frequency of policy-setting meetings was also based on the assessment of the past meetings of the Monetary Board and upon review of the practices of selected central banks. Results of comparative analysis showed that the frequency of past monetary policy meetings was definitely on the high side. The US Federal Open Market Committee (FOMC) meets to set policy rates on ten occasions each year. Britain’s Monetary Policy Committee has twelve scheduled meetings each year, largely enshrined in legislation. Chile and the European Central Bank have twelve policy-rate-setting meetings annually while the Bank of Korea holds monthly Monetary Policy Committee meetings. But a number of other countries have less: Australia has eleven (once a month except January), Sweden had seven in 2005 while South Africa had six in 2003. The BSP’s shift from holding monetary policy meetings every four weeks to every six weeks effectively reduces the number of policy-setting meetings from thirteen times a year to about eight or nine times a year. The BSP’s move towards a reduced frequency of policy meetings brings its policy cycle in line with those of the Bank of Canada, the Reserve Bank of New Zealand and the Bank of Thailand, all of which have eight monetary policy meetings a year. Shorter lag in the publication of highlights of policy meeting Meanwhile, the Monetary Board’s approval of the shorter publication lag will improve the transparency of monetary policy-making and convey to the public the Monetary Board’s view of monetary policy with greater promptness. The decision to shorten the lag in publication was also based in part on the survey conducted by the BSP on the practices of selected central banks. The survey showed that the lag in the publication of the minutes of monetary policy meetings ranges from one day to three months. The National Bank of Poland publishes the highlights of its meeting immediately on the following day. Meanwhile, the minutes are published with a lag of eight days by Banco Central do Brasil, two weeks by the Bank of England and Sveriges Riksbank, and three months by the Bank of Korea. Other non-inflation targeting central banks also release the minutes of their monetary policy meetings. The US Fed publishes with a lag of three weeks while the Bank of Japan issues the minutes with a five-week lag. It could be noted that the minutes of the Monetary Policy Committee meetings in the Bank of England were published
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originally six weeks after the date of the policy decision while the minutes of the US Fed’s policy-setting meetings were also originally released with a lag of six weeks.2 The BSP believes that a shorter time lag in the publication of the minutes of the Monetary Board meetings will enhance the BSP’s transparency in its monetary policy stance and will signal greater openness in communicating the overall thinking behind monetary policy decisions. Shortening the time lag is also consistent with the experience of other central banks which have strived to attain a high-degree of policy transparency through various modes of communicating with the public. Continuing improvement of the IT framework The BSP continues its efforts to strengthen the IT framework and enhance the conduct of monetary policy in the Philippines. These efforts include initiatives to improve econometric modeling for policy simulation and macroeconomic forecasting, greater emphasis on research, statistics and human development, and equipping the BSP with tools which are necessary in the assessment of the economic environment so that macroeconomic growth will be sustained through stable prices and a strong financial system. End Notes: 1 These experts were Prof. Bennett T. McCallum of Carnegie Mellon University and the National Bureau of Economic
Research in the US; Prof. Peter J.N. Sinclair of University of Birmingham, UK and Prof. Kenneth F. Wallis, University of Warwick, UK.
2 Various Central Bank websites
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V. INFLATION OUTLOOK
Inflation Forecasts
The balance of demand and supply conditions and the public’s expectations on future inflation provide a central influence on the inflation outlook. Recent data showed an improvement in demand conditions. Spurred by household consumption, increased government expenditure on the back of an improved fiscal situation, and higher public spending on infrastructure, GDP growth during the first quarter of 2006 hit the high end of the Government’s forecast despite hikes in crude oil prices and the increase in the value-added tax rate to 12 percent in February. Moreover, merchandise trade expanded at a solid pace, residential and office vacancy rates declined, vehicle sales picked up, and market confidence improved. Relative to the previous year, the unemployment rate for the April round of the labor force survey declined. Latest available data likewise indicate some pick up in liquidity and bank lending growth. Meanwhile, other indicators point to limited demand-based pressures. Growth in energy sales slowed down while appliance sales continued to fall. Moreover, core inflation has trended downward. On the supply side, world prices of crude oil have continued to rise amid lingering geopolitical issues, particularly in Iran and Nigeria; production problems in the US refineries; and the onset of the hurricane season in the US Gulf. On the other hand, food prices have eased on the back of favorable agricultural production. Near-term outlook on food supply remains positive based on expectations of increased harvest area and improvement in yields given favorable weather conditions.
Limited demand-based pressures and favorable agricultural production support the outlook for a manageable inflation environment.
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Meanwhile, inflation expectations appear to be well-contained. Results of the second quarter CES by the BSP indicated that households anticipate a slow down in inflation over the next 12 months. In addition, private sector analysts, as polled by the BSP, have lowered their inflation forecasts for 2006.
Staff estimates show that headline inflation is expected to continue to decelerate towards the end of 2006. However, average inflation in 2006 is still projected to exceed the Government-announced target of 4.0-5.0 percent due largely to above-trend oil price levels. Meanwhile, inflation could settle within the 4.0-5.0 percent target range in 2007 in the absence of renewed domestic or external shocks. The BSP’s forecasts are based on the following assumptions: a. Real GDP growth will average 5.5 percent in
2006 and 5.8 percent in 2007. b. National Government deficit levels will
amount to P124.9 billion in 2006 and P63.0 billion in 2007.
c. The overnight RRP rate was assumed
constant at 7.5 percent from July 2006 to December 2007.
d. The 91-day T- bill rates were assumed to
average at the low-end of the 6.8 – 7.5 percent DBCC projection for 2006 and at the high-end of the 4.8 – 5.5 percent projection for 2007.27
e. International crude oil prices are consistent with the latest BSP projections (as of 19 June 2006, based on futures prices) of US$63.64 for 2006 and US$67.64 for 2007. The impact on inflation of mitigating measures such as the reduction in import duty on diesel, kerosene and fuel from 5 percent to 3 percent was incorporated into the baseline forecast.
27 For the BSP’s Multi-Equation Model, the 91-day T-bill rates were determined endogenously.
Inflation is projected to continue to decelerate in the second half of 2006 and could settle within the target range in 2007.
Inflation expectations are still well-anchored.
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f. Baseline inflation forecasts incorporate the realized impact of the implementation of the VAT reform law that repealed the VAT exemption on power, petroleum products, and other commodities beginning November 2005 and increased the VAT rate to 12 percent from 10 percent in February 2006.
g. Nominal wage rate was assumed to
increase by 8 percent in June 2006 and by 5 percent in June 2007.
Risks to the Inflation Outlook
The fan chart depicts the probability of different inflation outcomes over the policy horizon and the uncertainty surrounding the baseline inflation forecasts of the BSP (or the central projection corresponding to the darkest band of the fan chart). The current inflation profile shows a marked decline in the future path of inflation over the near-term relative to that of the previous quarter. This is due mainly to the lower than projected inflation outturn for the second quarter. Moreover, easing food prices amid favorable outlook on agricultural production could help stabilize price movements. However, inflation is expected to rise slightly in the third quarter as the increase in the nominal wage takes effect. Thereafter, inflation is expected to slow down and possibly revert to the 4-5 percent official target in 2007, barring additional external and domestic shocks.
Latest fan chart shows a decline in the future path of inflation.
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Nonetheless, the wider bands of the current fan chart indicate greater uncertainty with respect to the future course of price movements. This is because world oil prices are expected to remain volatile over the policy horizon. Meanwhile the upward skew (the bands above the central projection of the fan chart are wider that those below it) of the fan chart, as in the previous quarter, illustrates that the balance of risks to the outlook for price developments remains tilted toward increased inflation pressures. The main risks surrounding the current inflation path relate to the volatility of oil prices, further adjustments in wages and movements of the exchange rate.
Inflation Profile as of Previous Quarter Latest Inflation Profile
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The fan chart shows the probability of various outcomes for inflation over the forecast horizon. The darkest band depicts the central projection, which corresponds to the BSP’s inflation baseline forecast. It covers 25% of the probability. Each successive pair of bands is drawn to cover a further 25% of probability, until 75% of the probability distribution is covered. The bands widen (i.e. “fan out”) as the time frame is extended, indicating increasing uncertainty about outcomes.
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Volatility of Oil Prices Imported oil prices remain a key risk factor in the outlook for inflation. Domestic pump prices continue to be subject to increases due to the impact of movements in imported crude prices. Sustained strong demand for oil against a backdrop of limited increases in world spare oil production capacity and continuing risks of geopolitical uncertainty are likely to keep oil prices high in the near term.
Further Wage Hikes Second-round effects in the form of further wage adjustments after the wage hike order for NCR in June 2006 remain possible given the pending applications for wage increases in the regional wage boards. Movements of the exchange rate Higher risk aversion in the global markets and concerns of hikes in the US Federal Reserve’s target rate have recently driven the local currency lower. On the domestic front, issues on the fiscal budget, the possible realignment of revenue targets among the revenue-generating agencies and questions about the sustainability of the overall fiscal position further weighed down on the peso. However, rising export revenue, improving investor sentiment and continuous inflow of remittances from overseas Filipino workers are seen to prop up the peso.
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Private Sector Economists’ Inflation Forecasts
4.0
4.5
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7.5
2004 Q3 2004 Q4 2005 Q1 2005 Q2 2005 Q3 2005 Q4 2006 Q1 2006 Q2
2006 2007
Mean Inflation Forecasts by Private Sector Economists/AnalystsIn percent
Private analysts lowered their inflation forecasts slightly for 2006 on evidence of lower food prices. Most analysts cited that robust production in the agriculture sector would limit price pressures from higher wages and pump prices of crude oil. Some analysts were of the view that high oil prices would not be sustained and that the peso would be stronger than its current level thus, keeping prices from rising sharply. At the same time, some economists pointed out that there are potential inflation risks from global crude oil prices, the country’s weak external payments position and intermittent political uncertainties. The mean inflation forecast for 2006 in this quarter’s survey declined to 6.9 percent from 7.1 percent in the previous quarter. For 2007, the mean forecast was 5.7 percent, slightly lower than the previous quarter’s 5.8 percent. Analysts also expect an improvement in economic activity both in 2006 and 2007. The mean forecast for real GDP growth in 2006 rose to 5.3 percent, from last quarter’s 5.0 percent. However, this is still below the government’s growth target of 5.5 percent - 6.2 percent. Analysts cited that stronger than expected agricultural production and export growth are likely to spur growth in 2006. They noted that personal consumption and healthy exports should be the major engines of economic growth. Also, fiscal consolidation is expected to increase this year’s public spending. For 2007, the mean GDP forecast rose to 5.2 percent from the last quarter’s mean forecast of 4.9 percent.
Private forecasters lower their inflation forecast for 2006 and 2007.
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VI. IMPLICATIONS FOR THE MONETARY POLICY STANCE
A number of factors support the maintenance of current policy settings in the near term. Latest staff forecasts continue to suggest a deceleration in inflation beginning in the second half of this year, leading to within-target inflation in 2007. In addition, core inflation and other recent data continue to paint a scenario of limited demand-based pressures in the near term. These conditions suggest an outlook of manageable inflation over the policy horizon.
The case for keeping policy rates unchanged is further strengthened by manageable inflation expectations (based on survey data) and the relative absence thus far of second-round effects on wage- and price-setting.
Nevertheless, the balance of risks to the inflation outlook remains tilted toward the upside, linked mainly to movements in oil prices. The prospect of continued oil price increases over the next few months, along with expected adjustments in domestic power costs, point to a continuing environment of supply-side pressures. Such a prospect increases the risks to inflation expectations and the likelihood of second-round effects, particularly on wage-setting.
Developments on the wage front in the next few weeks will need to be watched closely. The ongoing round of deliberations by various regional wage boards around the country points to the likelihood of wage adjustments in the coming weeks. However, the extent of the adjustments is unlikely to exceed the P25 increase granted in the NCR, which is consistent with the 8 percent already factored into the staff forecasts.
Outlook of manageable inflation environment supports the case for keeping policy settings unchanged.
Inflation expectations appear to be well-anchored and there is yet no clear evidence of second-round effects.
However, the outlook for inflation continues to be accompanied by risks, particularly those linked to oil prices.
Potential wage adjustments and its impact on the inflation dynamics need to be monitored closely.
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Managing the risks to inflation expectations, and the risk of potential second-round effects in wage- and price-setting, remains a key policy priority. There is some uncertainty about the extent of likely wage increases in the private sector, and developments in the wage front will thus require closer monitoring.
Good communication also remains important for managing expectations. Monetary authorities will need to clearly convey their readiness to act upon the evidence of escalating risks to the outlook for inflation and to the public’s inflation expectations.
At the same time, given that price pressures remain rooted in the supply side, public discussion of policy responses to high oil prices should be directed towards the role of non-monetary measures that can more directly address the impact of increased transport and energy costs. These measures could include price subsidies to diesel users, efforts to promote energy conservation and development of alternative fuel and energy sources.
VI. CONCLUDING REMARKS
The current global environment poses special challenges to central banks of emerging markets. Robust activity in the US and steady recovery in Europe and Japan may, at some point, require more aggressive tightening by the major central banks. Such a prospect increases the risk of capital outflows from emerging economies, which in turn can potentially pull down equity and property prices and cause volatility in the foreign exchange market.
Oil prices also remain a wildcard in the prevailing macroeconomic environment. Continued demand in major economies amid tight supply conditions can only mean further pressures on global energy prices, and therefore on inflation in price-taking emerging economies like the Philippines.
The main priority continues to be that of managing the risk of second-round effects.
Monetary authorities stand ready to undertake policy action if deemed necessary.
The BSP continues to support the use of non-monetary pressures to help ease the impact of supply-side related price pressures.
Current environment presents a challenge to monetary authorities.
Trends in oil prices remain the wildcard in prevailing macroeconomic environment.
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The prospect of rising interest rates in advanced economies, combined with rising inflation, would imply slower economic activity going forward if they serve to dampen consumer confidence and consumption. The risks to output are a key concern not only for the US but also for Asian economies where the US is a key market for exports.
The primary challenge to monetary policy, therefore, will be to find the right balance between addressing the risks to inflation and allowing the economy’s growth momentum to continue. Monetary policy going forward will thus proceed on a cautious footing. The BSP will continue to keep a close eye on incipient inflationary pressures, especially those coming from the demand side. Authorities stand ready to undertake the necessary monetary action in a timely manner, and remain vigilant in ensuring that these risks do not undermine economic growth.
Equally important are the organizational challenges posed to central banks by today’s global economy. Modern central banks must be able to deal effectively with rapid financial and technological innovation, increased global economic integration, structural economic change, and financial conglomeration.
For this reason, the BSP continuously strives to improve and strengthen itself as an institution. Such efforts are reflected not only in the enhancements to the operating framework for monetary policy but also in initiatives to strengthen technical capabilities within the bank. Moreover, effective monetary policymaking requires not only keeping pace with new analytical techniques but also good communication and transparency procedures that help deliver more clearly the policy message to financial markets and the rest of the economy. These areas continue to be the focus of the Bank's future initiatives to improve its policymaking framework.
The prospect of rising interest rates combined with higher inflation pose risks to output.
The challenge is to strike a balance between addressing the risks to inflation and allowing the economy’s growth momentum to proceed.
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Chronology of Monetary Policy Decisions
2000 24 January 2000 The Monetary Board–the policymaking body of the BSP–adopted in principle the shift to inflation targeting as the BSP's framework for conducting monetary policy. 2001 26 December 2001 The BSP announced formally the adoption of inflation targeting as framework for monetary policy beginning January 2002. The BSP also announced the Government’s annual average inflation targets of 5.0-6.0 percent for 2002 and 4.5-5.5 percent for 2003. 2002 17 January 2002 The Monetary Board decided to reduce the overnight RRP and RP rates by 25 basis points each to 7.5 percent and 9.75 percent, respectively. Consequently, the Monetary Board also adopted a change in the tiering structure for banks’ overnight RRP placements with the BSP as follows: 7.5 percent for the first P5 billion, 4.5 percent for the next P5 billion and 1.5 percent for placements in excess of P10 billion. The Monetary Board also approved a two-percentage point reduction to 7.0 percent of the liquidity reserve requirements on deposits and deposit substitute liabilities, common trust funds and other trust and fiduciary liabilities of commercial banks and non-banks with quasi-banking functions.
These monetary policy measures took effect on 18 January 2003. Moreover, it could be noted that this decision marks the first action of the Monetary Board under the inflation-targeting framework. 14 February 2002 The Monetary Board opted to lower the BSP’s policy rates further by 25 basis points each, bringing the overnight RRP rate to 7.25 percent and the overnight RP rate to 9.5 percent effective 15 February 2002. The Monetary Board also approved an adjustment in tiering scheme for banks’ overnight RRP placements with the BSP as follows: 7.25 percent for placements of up to P5 billion, 4.25 percent for the next P5 billion and 1.25 percent for placements in excess of P10 billion. The tiering scheme also covered special deposit accounts (SDAs) and would be applied on a consolidated basis. 14 March 2002 The Monetary Board decided to reduce BSP’s key policy rates by another 25 basis points. The overnight RRP rate was lowered to 7.0 percent while the overnight RP rate was reduced to 9.25 percent effective 15 March 2002. Correspondingly, the interest rates on overnight RRP and SDA placements with the BSP under the tiering scheme were adjusted as follows: 7.0 percent for placements of up to P5 billion, 4.0 percent for the next P5 billion and 1.0 percent for placements in excess of P10 billion.
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11 April, 8 May, 6 June, 4 July, 1 August, 29 August, 26 September, 23 October, 21 November, 19 December 2002 During the monetary policy meetings held for the period April-December 2002, the Monetary Board decided to keep the overnight RRP and RP rates steady at 7.0 percent and 9.25 percent, respectively.
2003 16 January 2003 The Monetary Board voted to keep the BSP’s policy rates unchanged at 7.0 percent for the overnight RRP rate and 9.25 percent for the overnight RP rate. 7 February 2003 The BSP announced the Government’s official target for the average annual inflation for 2004 at 4-5 percent. 12 February, 13 March 2003 The Monetary Board kept the BSP’s policy rates unchanged at 7.0 percent for the overnight RRP rate and 9.25 percent for the overnight RP rate. 19 March 2003 (Special Monetary Board Meeting) The Monetary Board decided to lift the three-tiered scheme on banks’ placements with the BSP. Thus, overnight placements under the RRP window would be accepted at a flat rate of 7.0 percent effective 20 March 2003. The Monetary Board also raised the liquidity reserve requirement against peso demand, savings, time deposit and deposit liabilities of universal banks and commercial banks by one-percentage point to 8.0 percent effective 21 March 2003.
10 April, 8 May 2003 The Monetary Board maintained the overnight RRP and RP rates steady at 7.0 percent and 9.25 percent, respectively. 5 June 2003 The Monetary Board decided to leave the overnight RRP and RP rates unchanged at 7.0 percent and 9.25 percent, respectively. The Monetary Board also decided to restore the tiering scheme on banks’ placements with the BSP under the RRP and SDA windows effective 5 June 2003. In particular, overnight RRP placements would be subject to the following interest rates: 7.0 percent for the first P5 billion, 4.0 percent for additional amounts in excess of P5 billion but below P10 billion and 1.0 percent for amounts in excess of P10 billion. 2 July 2003 The Monetary Board voted to reduce the BSP’s key policy interest rates by 25 basis points each to 6.75 percent for the overnight RRP rate and 9.0 percent for the overnight RP rate effective 2 July 2003. The interest rates on banks’ placements under the tiered system were also adjusted as follows: 6.75 percent for the first P5 billion, 3.75 percent for amounts in excess of P5 billion up to P10 billion and 0.75 percent in excess of P10 billion. 31 July 2003 The Monetary Board left the overnight RRP and RP rates unchanged at 6.75 percent and 9.0 percent, respectively. 28 August 2003 The Monetary Board opted to keep the BSP’s policy rates unchanged at 6.75 percent for the overnight RRP rate and 9.0 percent for the overnight RP rate. The Monetary Board also decided to lift the tiering scheme for banks’ placements with the
Fourth Quarter2005
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BSP. Thus, effective 28 August 2003, overnight RRP transactions with the BSP were accepted at a flat rate of 6.75 percent. 2 October, 23 October, 20 November, 18 December 2003 The Monetary Board voted unanimously to leave the BSP’s policy rates unchanged at 6.75 percent for the overnight RRP rate and 9.0 percent for the overnight RP rate.
2004 15 January 2004 The Monetary Board decided to keep monetary policy settings unchanged. The overnight RRP and RP rate were maintained at 6.75 percent and 9.0 percent, respectively. 5 February 2004 (Special Monetary Board Meeting) The Monetary Board decided to increase the liquidity reserve requirement for universal banks and commercial banks by two percentage points to 10 percent effective 6 February 2004. 12 February, 11 March, 15 April, 6 May, 3 June, 1 July, 29 July, 26 August, 23 September, 21 October, 18 November, 16 December 2004 The Monetary Board opted to maintain the key rates steady at 6.75 percent and 9.0 percent for the overnight RRP rate and overnight RP rate, respectively. 2005 13 January, 10 February, 10 March 2005 The Monetary Board decided to maintain the BSP’s key overnight RRP and RP rates unchanged at 6.75 percent and 9.0 percent, respectively.
7 April 2005 The Monetary Board voted unanimously to raise the overnight RRP and RP rates by 25 basis points each to 7.0 percent and 9.25 percent, respectively.
5 May, 2 June, 30 June 2005 The Monetary Board decided to keep the BSP’s policy interest rates at 7.0 percent for the overnight RRP rate and 9.25 percent for the overnight RP rate. 7 July 2005 (Special Monetary Board meeting) The Monetary Board raised the regular and liquidity reserve requirement ratios by 100 basis points each to 10 percent and 11 percent, respectively, effective 15 July 2005. 28 July, 25 August 2005 The Monetary Board left key policy rates unchanged at 7.0 percent and 9.25 percent for the overnight RRP rate and overnight RP rate, respectively. 22 September 2005 The Monetary Board decided to raise the overnight RRP rate and RP rate by 25 basis points to 7.25 percent and 9.5 percent, respectively. 20 October 2005 The Monetary Board raised the key policy rates by 25 basis points to 7.5 percent and 9.75 percent for the overnight RRP and RP rates, respectively. 17 November, 15 December 2005 The key policy rates were left unchanged at 7.5 percent and 9.75 percent for the overnight RRP and RP rates, respectively.
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2006 12 January, 9 February, 9 March, 6 April, 4 May, 1 June, 29 June 2006 The Monetary Board decided to maintain the policy rates at 7.5 percent and 9.75 percent for the overnight RRP and RP rates, respectively.
The BSP Inflation Report is published every quarter by the Bangko Sentral ng Pilipinas. The report is available as a complete document in pdf format, together with other general information about inflation targeting and the monetary policy of the BSP, on the BSP’s website:
www.bsp.gov.ph/monetary/inflation.asp If you wish to receive an electronic copy of the latest BSP Inflation Report, please send an e-mail to [email protected]. The BSP also welcomes feedback from readers on the contents of the Inflation Report as well as suggestions on how to improve the presentation. Please send comments and suggestions to the following addresses:
By post: BSP Inflation Report
c/o Department of Economic Research Bangko Sentral ng Pilipinas
A. Mabini Street, Malate, Manila Philippines 1004
By e-mail: [email protected]
