BSP, the Philippines’ central bank, has begun rate hikes to tackle the country’s highest inflation rate since 2018. After two 25-basis point (bp) hikes in May and June, the BSP raised interest rates by 75bp to 3.25% on July 14, a surprise move that signalled a more aggressive monetary policy to come.
Felipe Medalla, who took over the role of governor of the BSP on July 1, spoke to FinanceAsia about this decision, and shared his outlook for the county’s growth and digitisation path.
FA: You are taking on the role of BSP governor at a time of unprecedented macroeconomic headwinds and global uncertainty. What are your immediate priorities, and what will you do differently to your predecessor?
Felipe Medalla (FM): I’m serving the final year of a term that was started by two governors. Unfortunately, governor [Nestor Aldave] Espenilla passed away, and after that, Benjamin Diokno was appointed secretary of Finance under the new administration.
One thing I can say about central banking is that many things don’t change. What keeps changing is the environment and the technology. Therefore, we must be agile enough to respond to the changes. I’ve been in the Monetary Board for 11 years, and the recent unanticipated changes in US monetary policy is really one for the books. In the Philippines, what we thought was transitory inflation is clearly not. That’s now coupled with supply-side effects of the Ukraine war, in addition to the pandemic which disrupted supply chains. On top of that, weather problems are making some important locally produced food items more expensive.
Most of these factors, including high oil prices, are supply-side effects, and therefore very hard to address with monetary policy tools. To make matters even more difficult, most are external to the country. Nonetheless, we have to worry about how all these changes will “disanchor” inflationary expectations.
We want to make sure that when the supply shocks are gone, we can quickly go back to a target-consistent path of inflation. If the BSP acts too late, it will be harder to achieve that in the future. On the other hand, if we act too much, we may end up killing what we call a nascent recovery. We’re very happy that in the first quarter of this year, growth is 8.3%.
That’s the balancing act – how to prevent knock-on effects of the current shocks, and still have a strong economy.
I think it can be done. The Philippines has certain advantages, including our young population, which makes it very easy to stimulate demand, and our more-than-adequate international reserves.
We expect inflation to be much higher than 5% in the next two or three months and then start tapering down. If oil prices continue their current downward trajectory, it [inflation] will hit the target of 2-4% next year and subsequently fall below 4%. That is what we’re aiming for, and we are willing to deploy all the tools in our toolkit to achieve that.
It’s important to realise that our tools work with a time lag, six to 12 months based on our studies. The effects on current inflation are not going to be very large, also because the current inflation is largely supply shocks. We’re expecting our current policies to prove successful when things normalise.
FA: The recent 75bp hike caught analysts by surprise. How fluid would you say the country’s monetary policy is?
FM: There are two things that made this latest hike unusual: the timing and the size. The next scheduled monetary board policy meeting is August 18. The hike happened more than a month earlier than programmed. Additionally, we never did 75 basis points before.
There are two reasons why we're concerned about the exchange rate, which we’re usually not. The first is that the peso depreciation has been quite substantial, more than 8% year-to-date.
Much of our data on the computation of elasticity [of consumer prices to the exchange rate] is based on small changes in the exchange rate. We are afraid that the equation is nonlinear – that the elasticities will be bigger for large changes.
Moreover, we are expecting the US to do even more [monetary tightening] than it's already doing, so we felt the pressures to act were getting stronger. We're also observing larger adjustments in government-regulated minimum wages.
Combining these pressures, the Board unanimously felt we had to act quickly and significantly.
FA: At what point would BSP interfere in the forex market to keep the exchange rate within range?
FM: Oftentimes, changes in the exchange rate work in the correct direction, that is making the economy more efficient. The problem is that very large changes may make people use the exchange rate, rather than our announced forecasts, as a basis of forecasting inflation. We have to be quite concerned about that.
The other part of the dynamic is that if reserves fall too much, market participants will think us less likely to be active in the future, because we’ve run out of things to sell. The high interest rates in the US, plus the safe haven characteristic of the US dollar, make the pressure much higher.
So far what we’ve done worked, has worked -- it made the peso significantly less volatile. We're glad we did it because I think the growth of the economy is robust enough to take it. Of course, it’s hard to say when growth stops being robust. That’s why it’s a balancing act, and that’s why we’re waiting for more data. We don’t want to overreact.
FA: The Philippines’ debt-to-GDP ratio, at 63.5%, is at a 17-year high. How can the Philippines maintain confidence with foreign investors?
FM: What's happening has clearly affected foreign investment. There have been more outflows, both from peso-denominated government securities, and from the stock market. The good thing is that it seems not to be affecting FDI. Indeed, FDI now is higher than before. What that suggests is that if you’re looking long-term, the advantages of investing in the Philippines remain.
Some of the investment targeted at Philippine markets, some of it is in finance. So, my guess is that investors think that the returns are good enough to offset fears around the exchange rate they will get when converting pesos into dollars. But I think the FDI investor is looking way beyond the exchange rate next year.
The Philippines has certain demographic advantages, including a largely English-speaking labour force. Many of our accountants use American accounting practices and our lawyers understand the US legal system.
However, I won’t be very balanced if I said that I didn’t have any worries. My main worry is that a direct investor in manufacturing might prefer Vietnam to the Philippines. So, those are the long-run issues. The government is wondering to what extent the country’s infrastructure and logistics, and its interventions in labour markets and contracts, will be an issue.
Of course, the central bank is more like a resource person; the major decisions are to be done by the cabinet. I think those guys are wonderful, both in the sense of patriotism and professionalism, as well as their skills. That’s why I remain optimistic.
Of course, if the economy is growing very fast, then the denominator in the debt-to-GDP equation goes up. So, growth solves many of our fiscal problems. That’s why growth is extremely important.
FA: How do you assess efforts to promote the development of green finance in the Philippines?
FM: Sustainability requires a whole-of-government-and-society approach. Whatever we do in the financial sectors will not amount to much if the underlying values and behaviours are not in place.
Having said that, if the regulatory and value system is consistent with improving the climate, then the right finance should facilitate it. For instance, regulation should make it cheaper to float green bonds. We should have the correct taxonomy to prevent greenwashing, and that’s something we are doing.
In addition, financial institutions should do their part such that, all other things equal, a green borrower should be preferred to one that is not green.
Of course, even getting ASEAN to have common definitions will require time, so a lot of work is going on, and we should continue pursuing that.
FA: I understand you’re not a big fan of cryptocurrencies.
FM: My problem with crypto is that, when the price is rising, nobody wants to use it. They hold it. On the other hand, when the price is falling, nobody wants to receive it. So, it does not have enough stability to be used for transactions.
To make matters worse, bitcoin mining consumes more energy than whole countries.
Thirdly, existing systems can facilitate transactions 100 times faster than distributed ledger technology can. So, for countries like the Philippines and in ASEAN, crypto is, in many ways, inferior to the old ways of doing things.
The other issue is KYC. If you’re sending and receiving virtual currency, it’s your duty to know who your clients are. You should be as responsible as the banks in this regard. There is definitely a fear around the use of virtual currencies for drugs or financing terrorist acts, or to avoid taxes.
A benefit in the Philippines is that people have confidence in the convertibility of the domestic currency to the US dollar. Now, the problem is that the global currency is run by a very unpredictable democracy – but one ignores US monetary policy at one’s own peril.
FA: How do you assess the progress made in payments digitisation and linking of the Philippines’ real-time payments systems with other countries? How will this benefit Filipinos?
FM: The number of users of our Fast Payment System (FPS), InstaPay, has skyrocketed, bolstered by the emergence of [virtual wallets] GCash and PayMaya, which allowed even people without bank accounts to enter the financial system. We're quite happy with the rate at which it’s going.
The major limitation is there are areas of the Philippines that have poor or no phone coverage. Indonesia is worth looking at in that respect – they are treating phone signal infrastructure development almost as seriously as road development, and I think they're investing in satellites.
Now we’re looking at the use of FPS for cross-border payments. There are technical challenges with message formats and protocols differing across countries which we can reconcile, but that’s not straightforward.
BIS invested in a project called Nexus which would allow countries to just plug in their FPS to a platform. But, at the moment, what we are trying to do is develop bilateral agreements. The most natural agreement for us are Singapore and Malaysia, but we plan to do more bilateral agreements in the future.
All of us can start bilateral with the idea of eventually transitioning to a multilateral approach. This would require the presidents of the involved countries to sign on. Given the record of ASEAN, I think they would.
Of course, we will have to ensure user confidence on the fairness of the exchange rate to be used for conversion. So there has to be a good system of exchanging currencies, perhaps leveraging the big banks. I think those problems can be solved. My vision is that a Filipino travelling to Singapore or Malaysia, need only use his phone to make transactions. I think the leadership of all countries would want that to happen. With the development of platforms that make it easy to plug in, this could be a reality sooner than most of us expect.
FA: What is BSP doing to promote fintech innovation?
FM: We’re looking at a wholesale CBDC, which is just the virtual version of the fiat currency, to facilitate large, cross-border transactions between financial institutions.
Another thing on fintech is there’s an explosion of online lenders. What concerned us was the somewhat unethical collection methods, such as peer shaming. The concern is to make sure that this technology is used properly and not abused.
We are encouraging banks that are strictly purely digital. Our policy is that if you have a non-digital component, you cannot call yourself a digital bank.
At the same time, we are trying to make sure that our regulatory capacity is not overwhelmed, so we’ve limited the initial number of digital banks to six for now. As we get better at it, we can become more open. In other words, we are very open to new technologies, but we're also watchful that people are not abused. We have to be very conscious of consumer protection.
FA: How will you work with the new administration for the future prosperity of the Philippines?
FM: I've met the president only twice, because the view is that the central bank is independent.
But there are committees where the BSP is a resource institution, such as the Economic Development Cluster, the Social Development Committee, the Development Budget Coordination Committee, etc.
One thing you can say about the Philippines is that, regardless of who’s president, there's continuity in monetary and macroeconomic policy.
My view is that this administration will continue the reforms of the previous ones and improve upon them. I think we can be proud of the continuity of fiscal and monetary policy, and macroeconomic policies, as well as debt management.
FA: What is your outlook for the country’s growth rate?
FM: We expect growth this year to be between 6.5% and 7.5%, and next year between 6.5 and 8%.
There is no point making forecasts beyond that because the standard deviation is quite large.
But we have the vision that we will continue to grow at over 6% many years beyond, which we did for 10 years before the pandemic.
In fact, when you look at the 10-15 years before the pandemic, we had both rising growth rates and falling poverty incidence. So, we must have been doing something right. With the pandemic becoming endemic, we hope that we will be able to start where we left off two or three years ago.
