25 January 2019
RODRIGO R. DUTERTE
Republic of the Philippines
Dear Mr. President:
Pursuant to Resolution No. 2002-01 of the Development Budget Coordination Committee (DBCC),1 we issue this open letter to the President and the Filipino people to explain why the 2018 average inflation of 5.2 percent exceeded the National Government’s (NG’s) target range of 3 ± 1 percent for the year.2 We also seek to explain the rationale behind our monetary policy decisions in 2018, as well as our assessment of the inflation outlook and policy directions for 2019 and 2020. This is in line with the BSP’s commitment to promote greater transparency and accountability as well as greater understanding of monetary policy under the inflation targeting framework.
The inflation target refers to the average headline inflation rate during a year. The DBCC determines the target while the BSP announces it at least two years ahead. For 2018, the DBCC set the target at 3 ± 1 percent on 27 January 2015. 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 2018?
Supply-side factors drove inflation in 2018. The increase in domestic pump prices of oil products mirrored the continued rebound in international crude oil prices amid geopolitical tensions and production cutbacks among major oil-producing countries. Food inflation also rose as a result of supply bottlenecks associated with adverse weather conditions and seasonal typhoons in the middle part of the year, which constrained the supply of key food items, particularly rice, meat, fish, and vegetables. At the same time, the direct and indirect effects of the excise tax reforms at the start of the year also contributed to price pressures. The increases in domestic food and oil prices drove second-round effects, as transport groups petitioned for increases in minimum fares while various labor groups lobbied for upward adjustments in minimum wages across the country. These developments pushed inflation beyond the target range of 2-4 percent in 2018.
How did the monetary authorities respond to emerging challenges to the inflation outlook over the policy horizon?
In keeping with its conduct of monetary policy under flexible inflation targeting, the BSP decided to maintain its monetary policy settings in early 2018 as its inflation forecasts remained within the target range and as inflation expectations showed no signs of being disanchored. Communication with the public also emphasized that the capacity of monetary policy to combat inflation is limited when price spikes are driven by cost-push forces such as the rising price of crude oil in the international market, adverse weather conditions, or tax reform measures. Like most central banks, the BSP would rather look through the initial effects of supply shocks, which tend to be transitory based on past experiences.
Nevertheless, the BSP remained on guard against sustained inflation pressures, even as we expressed our support for carefully coordinated efforts among government agencies to mitigate the impact of inflation on social welfare. Indeed, rising inflation expectations and early signs of second-round effects during the second quarter of the year underscored the risk posed by sustained price pressures on future wage and price outcomes. For this reason, the BSP delivered a series of monetary tightening measures from May to November 2018. The cumulative 175-basis-point hike in the key policy interest rate was aimed at anchoring the public’s inflation expectations to help ensure that the price pressures would not evolve into sharper gains in wages, transportation fares, and prices of other goods and services.
What is the outlook for inflation and monetary policy?
Inflation readings as of late have been encouraging. In line with our projections, both headline and core inflation have begun to decline in the last quarter of 2018. We have also observed two consecutive months of negative month-on-month inflation readings starting in November. This indicates that demand pressures have not built up significantly and that the supply-driven inflation process we saw in 2018 was not to be persistent. [Headline inflation rate for December 2018 at 5.13 percent was lower than the 6.03 percent in November, 6.68 percent in October, and 6.70 percent in September.]
Looking ahead, we are optimistic that inflation will continue to ease in the coming months given our monetary tightening in 2018 as well as the NG’s decisive anti-inflation measures, including the liberalized importation of key commodities such as rice, meat, fish, and sugar. The early implementation of the rice tariffication law and the sustained administrative reforms to address supply-side bottlenecks, in particular, further strengthens our outlook that the inflation target will be achieved in 2019 and 2020.
We assure the President and the Filipino people that the BSP shall continue to confront inflation with an appropriate and vigilant stance of monetary policy. The BSP reiterates its strong commitment to achieving the inflation target over the medium term and stands ready to respond to any remaining and emerging risks that could compromise its primary mission of price stability.
For the consideration of the President.
CHUCHI G. FONACIER
1 The DBCC is composed of the principals of the Department of Budget and Management (DBM), Department of Finance (DOF), National Economic and 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 27 January 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. On 22 December 2017, the DBCC decided to keep the inflation target at 3 ± 1 percent for 2018-2020.