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The BSP and Inflation: What Mission Creep?

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Raul V. Fabella

Introspective

The BSP and Inflation: What Mission Creep?

The inflation rate reached 5.2% in June 2018 following 4.6% the month before. The June level is the highest in five years and breached the price target ceiling. Critics are lashing about to find fault. Demonizing TRAIN 1 is everywhere in the media and talks of rejiggering the act is afoot. Sadly, President Duterte revealed that he would leave the fate of his regime’s cornerstone economic program to a Congress that is facing midterm elections! That seems to leave his economic team in a lurch. Meanwhile, the detractors have extended the compass of their blame game to the BSP.

Even Senator Grace Poe, normally better advised and more circumspect, lent her pulpit to the finger pointing.

In May and again in June 2018, BSP raised the policy interest rate by 25 basis points. Banks have lined up to take advantage and have tendered upwards of P125 billion for the P100-billion BSP term deposit auction offers. Critics say that the BSP has sat on its hands and that the BSP should have preempted the subsequent inflationary pressure. Speculation has it that this represented a departure from the BSP’s primary mandate of price stability, and in favor of growth ? a “mission creep,” screamed the PDI editorial (PDI, 2 July 2018) which dignified these brickbats. It insinuated that BSP Governor “Nesting” Espenilla’s personal bias was subverting the mandate of the BSP only to leave a blot on the BSP’s admirable past performance. The critics and PDI are however patently wrong on many counts.

Firstly, when the price spike is due to a cost push (food, coal tax and higher transmission charge, rice and NFA failure, wages and “endo”) which PDI editorial conceded, the BSP’s capacity to combat the root of the spike is very limited. A more aggressive BSP interest rate hike would only raise costs and inflation further. Indeed, the May and June policy rate hike is aimed at dampening the inflation expectation; as well, it serves to mitigate the effect of US rate hike which would surely pull portfolio capital away from the country. Only when the price spike is demand-driven has an interest rate hike considerable leverage at removing root cause — excess liquidity. The latter is hardly the case here.

Secondly, to say that the BSP should have anticipated and preempted all the factors contributing to the current inflationary pressure is a counsel for recklessness. Knowing that an event such as the US interest rate hike is forthcoming is hardly sufficient if how much is the hike and when it comes are up in the air. You need the how much and when to formulate a proper response. The BSP is not God!

Thirdly, the TRAIN version of the DoF, which was public knowledge — and for which the DoF inflation impact simulation was based — did not include the coal tax and the lifting of the VAT-free status of power transmission, which raised electricity bills quickly. This was the folly of Senator Angara and the Senate, which nobody anticipated, but which President Duterte could have and should have vetoed to protect the integrity of the program.

Fourthly, to claim that the BSP and its top brass “have performed admirably for most of its quarter century existence” is a false claim to make the current dispensation look bad. On prices alone, inflation from 1993 (when the new BSP law was enacted) to 2001 averaged 7.4% annually. An annual inflation of 8-9% was something you took in stride in the 1990s. The average annual inflation for the following nine years (2003-2010) was 5.5%. This was above the inflation targets at that time. What record is Gov. Espenilla’s performance a blot on? In those nine years up to 2010 following the adoption of inflation targeting under Gov. Tetangco’s watch, inflation breached 6% four times.

Furthermore, it is a matter of record that the BSP, under Gov. Gabriel Singson, told private business (complaining of BSP’s high interest rate regime to keep the peso from depreciating) to source their borrowing from abroad in dollars. This created the massive currency mismatches which shredded Philippine banks’ balance sheets and the country economy’s vitality during the Asian financial crisis. It was the Jobo bill era surreality reprised: while the Philippine economy was dying of credit starvation, the country’s banks became obese from riskless and high interest placements in the BSP’s Special Deposit Account (SDA). To say that Governor Espenilla’s watch to date is a blot on this record stands evidence on its head.

It is however well known that monetary authorities both here and abroad have, in the past, used — and still do — a high interest rate regime to dampen inflation. High interest rate attracts portfolio capital which, like steroids, artificially bulks up the local currency, cheapening imports, and dampening the inflationary pressure.

Before the era of open capital account, the strong currency-cheap imports nexus was almost canonical to our monetary and fiscal authorities until the 1990s. As chief prop for the “beauty parlor industrialization policy” in the 1950s and 1960s, it saw assembly plants sprout which depended on artificially cheap imported inputs. The result was a “missing middle” problem: the intermediate inputs industry never developed. Why, indeed, produce intermediate inputs when you can import them cheaper! Philippine manufacturing and industrialization remained skin-deep and stunted. Why the Philippines moved from top to bottom in the East Asia economic league table is not a mystery.

In the era of open capital account and interest rate parity theory of the 1990s, the strong peso-cheap import nexus acquired a new ally, mobile capital. Now high interest rate can be enlisted to prop up the peso. The “high interest rate-strong peso-cheap imports” nexus was the rapier that BSP Governor Gabriel Singson wielded in the mid-1990s resulting tragically on the abortion of the hopeful Ramos recovery.

A broadly similar turn of events happened a decade ago when high global grains price spiraled and the global financial crisis came calling in Philippine shores. Let me quote the late former BSP Board member and UP Professor Cayetano “Dondon” Paderanga’s perceptive ruminations (“Slowly but surely,” Introspective, BW, 11 August 2008) on the subject.

“The Bangko Sentral ng Pilipinas (BSP) is under fire these days over its policy moves in fighting inflation. Though its rate hikes are perceived to be in the right direction, some quarters believe that the central bank is acting too slowly, putting its credibility and, consequently, the economy at risk. At the center of the debate are its policy rate changes which were done fairly recently and on a staggered basis.”

At that time of writing in August 2008, core inflation reached 5.8% year-to-date compared to 2.8% in 2007. By yearend, inflation was eight percent! There was a clamor for an “interest rate cure,” a large determined hike in the policy rate. Dr. Paderanga observed that increasing interest rates drastically may dampen an overheating economy if inflation was a demand-pull variety. But the inflationary pressure at this time came from the supply side: fuel prices have risen and global food prices have shot up. Paderanga thought the BSP was right in being cautious. He further observed that the use of the interest rate cure (very high interest rate) to mitigate capital flight in the 1980s under then-Central Bank of the Philippines Governor Jobo Fernandez brandishing the infamous “Jobo bills” led to a massive credit squeeze that reduced supply of just about everything, thus, worsening inflation. It was surreal: while the country’s business starved of credit, the banks that bought Jobo bills grew fat. Dr. Paderanga’s, though a blast from the past, poses the question: What mission creep?

 

Raul V. Fabella is a retired professor of the UP School of Economics and a member of the National Academy of Science and Technology. He gets his dopamine fix from hitting tennis balls with wife Teena and bicycling.