20 January 2017
RODRIGO R. DUTERTE
Republic of the Philippines
Dear Mr. President:
Pursuant to Resolution No. 2002-01 of the Development Budget and Coordination Committee (DBCC)1 , we issue this open letter to the President and the Filipino people to explain why the 2016 average inflation of 1.8 percent was lower than the National Government’s (NG’s) target range of 3 ± 1 percent for the year2 . We also seek to explain the rationale behind our monetary policy decisions in 2016, as well as our assessment of the inflation outlook and policy directions for 2017 and beyond. This is in line with the BSP’s commitment to promote greater understanding of monetary policy under the inflation targeting framework.
The inflation target refers to the average inflation rate during a year. The DBCC sets the target while the BSP announces the target at least two years ahead. For 2016, the target was set at 3 ± 1 percent by the DBCC way back on 28 November 2012. In subsequent DBCC meetings, the annual inflation target was set at 3 ± 1 percent for the period 2017 – 2020.3
What happened to prices in 2016?
Price movements in 2015 were subdued. But in 2016, inflation started to show an upward path, in line with the NG’s medium-term expectations and the BSP’s projections. The adverse impact of El Niño weather conditions and seasonal typhoons on the supply of key food items such as meat and vegetables contributed to the uptick in food inflation especially towards the latter part of the year. Nonetheless, the supply of food commodities, including rice, remained generally adequate and reined in further increases in food prices. Meanwhile, the sustained glut in global oil supply continued to temper international crude oil prices and exerted downward pressures on domestic oil pump prices, transport fares, and electricity rates. While international crude prices rebounded in late 2016 following plans of production cutbacks among major oil-producing countries, the increase in prices was not enough to offset the substantial decline seen in 2015. Together, these factors contributed to the slight acceleration in headline inflation, although the full-year average was still below the inflation target for 2016.
How did the monetary authorities respond to emerging challenges to the inflation outlook over the policy horizon?
The BSP decided to maintain its monetary policy settings in 2016 despite inflation hovering below the NG’s inflation target. In its communications to the public, the BSP made it clear that domestic price movements in 2016 continued to be driven mainly by transitory supply-side factors that were outside the influence of monetary policy. Moreover, the BSP’s inflation forecasts during the year showed inflation returning to the target by 2017. At the same time, the BSP observed that expectations of the public on future inflation remained aligned with the official inflation target over the 2017 – 2018 policy horizon. Equally important, the BSP noted that while global economic conditions remained subdued, domestic economic growth remained firm and hardly requiring additional monetary stimulus owing to robust private household consumption and investment. Business and consumer sentiment also stayed buoyant in 2016. Robust domestic activity is in turn supported by ample domestic liquidity (M3) and credit activity, with M3 growing by 12.7 percent year-on-year as of November 2016. These considerations supported the BSP’s decision to keep its monetary policy settings steady during the year.
What is the outlook for inflation and monetary policy?
The latest baseline forecasts of the BSP continue to indicate that inflation is likely to return gradually to a path consistent with the inflation target in 2017-2018. We expect inflation to continue gathering pace in the year ahead, with international oil prices seen to increase as a result of recent agreements by producers to reduce output. Looking ahead, we also expect the Philippine economy to be able to absorb external shocks and sustain its growth trajectory. Firm domestic demand conditions and ongoing reforms including on the fiscal front, continue to provide solid footing for steady expansion.
The overall balance of risks surrounding the inflation outlook is also tilted to the upside, owing in part to the pending petitions for adjustments in electricity rates as well as the initial impact of the NG’s broad fiscal reform program. Lingering uncertainty in global economic prospects, however, continues to pose a downside risk to the inflation outlook.
We would like to assure the President and the Filipino people that the BSP will continue to closely monitor domestic and external developments that could pose risks to the inflation outlook. This is to ensure that monetary policy continues to support the economy’s momentum for sustained non-inflationary growth. The BSP reiterates its strong commitment to achieving the inflation target over the medium term and stands ready to respond to any emerging risks that could threaten the attainment of price stability.
For the consideration of the President.
AMANDO M. TETANGCO, JR.
1 The DBCC is composed of the principals of the Department of Budget and Management (DBM), Department of Finance (DOF), National Economic Development Authority (NEDA), and the Office of the President (OP). The BSP was invited to join the DBCC as a Resource Institution per DBCC Resolution No. 98.1 dated 22 June 1998 to provide inputs on monetary measures and policies.
2 Under DBCC Resolution No. 2002-01, the BSP shall issue an open letter to the President explaining the reasons behind any deviations of actual inflation from the inflation target for a given year. The DBCC approved the Resolution on 8 March 2002, following the BSP’s formal adoption of the inflation targeting framework in January 2002.
3 On 3 February 2015, the DBCC set an inflation target of 3 ± 1 percent for 2017-2018. During its meeting on 20 December 2016, the DBCC decided to retain the inflation target of 3 ± 1 percent for 2017-2018 and also set the same target range for 2019-2020. These decisions were announced to the public on 22 December 2016.