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Reflections and Resolutions

Date: 01.24.2019

Place: Ballroom, New World Hotel

Occasion: Rotary Club of Manila Luncheon Meeting

Speaker: Governor Nestor A. Espenilla, Jr., as delivered by Deputy Governor Diwa C. Guinigundo

It is a matter of tradition that when a new year begins, resolutions are made.  The BSP’s resolve for 2019 has remained unchanged.  We are resolute in our commitment to our mandates of price stability, financial stability and in maintaining an efficient payments and settlements system.  Before I share our commitments, allow me to reflect on the year that was.

When 2018 began, there was optimism brought about by the global economic upswing and continued global expansion.  These were mainly driven by resurgent investment spending in advanced economies as well as higher investment and stronger private consumption in emerging market economies.  The International Monetary Fund itself used phrases like “Brighter Prospects” and “Optimistic Markets” in its January 2018 Update of the World Economic Outlook.

However, by October 2018, the IMF downgraded its global growth forecast.  By the fourth quarter of last year, it highlighted “Challenges to Steady Growth” citing escalating trade tensions between the United States and China, elevated policy uncertainty, dampened business and financial market sentiments, financial market volatility, and a slowing down of investment and trade.  In 2018, the global economy had to deal with the US Fed tightening cycle.  And while continued normalization of US monetary policy signifies strengthening of US economic activity, it also portends tightening financial conditions. 

This has caused portfolio adjustments, sharp exchange rate movements and reductions in capital inflows to emerging markets.

And based on the January 2019 update of the IMF’s World Economic Outlook (released last January 21), the global expansion is weakening at a rate that is somewhat faster than expected, which warranted a further downgrade to the October 2018 projections. 

Challenges brought by these external events were reflected on the domestic front.  As of 28 December 2018, the Philippine peso depreciated by 5.04 percent against the US dollar.  Other regional currencies also weakened against the US Dollar.

While recent depreciation of the peso is partly due to non-fundamental factors (such as market sentiments on external and domestic developments that add more pressure on the Philippine peso), other fundamental factors also account for the peso’s depreciation… this includes a higher demand for imports of capital goods, raw materials and intermediate products. 

This is a good sign as it is to be expected of a growing economy.  It also reflects dollar debt repayments, prepayments, and outward investments.  I emphasize that the peso’s movement is consistent with our strong macroeconomic fundamentals.

To help ease demand pressures in the foreign exchange spot market, and provide hedging facility for those with foreign currency-denominated borrowings, the BSP reactivated the Currency Rate Risk Protection Program or CRPP in September 2018. 

For most of 2018, we also had to deal with price pressures. Supply-side factors such as tightness in domestic supply, specifically of rice, meat and fish; higher prices of domestic petroleum products, due largely to higher international crude oil prices; upward adjustments in utility charges; weather–related disruptions, and implementation of excise tax reforms at the start of the year were the main drivers of higher inflation. 

As a response, the government pursued immediate measures to address inflationary pressures emanating from supply-side factors. This includes the implementation of the Rice Tariffication Bill and reforms in the rice industry that are expected to help sustain the inflation downtrend in the near term.

The BSP also undertook, as a proactive measure, successive monetary policy tightening in 2018 to prevent these supply shocks from propagating into second-round effects, and to ensure that inflation expectations remain well-anchored.

Headline inflation for 2018 was recorded at 5.2 percent from 2.9 percent in 2017.   Based on the BSP’s assessment of the future inflation path, inflation is expected to return to target this year (2019) and in 2020, to 3.2 percent and 3.0 percent, respectively in the absence of further shocks. These are well within the Government’s inflation target range of 2 to 4 percent.

The latest GDP outturn (6.1 percent for Q4 2018 and 6.2 percent for fully year 2018) shows a lower figure relative to last year’s (6.5 percent for Q4 2017 and 6.7 percent for full year 2017).  Nonetheless, this latest GDP growth rate remains above the long-term average trend of 5.3 percent (for 2000-2018).

We continue to achieve uninterrupted growth for the past 80 consecutive quarters, or 20 years.  And we remain one of the fastest growing economies in Asia. 

Latest IMF projections indicate that the Philippines will remain one of the best performing economies in the region in 2019.  This assessment is broadly in line with the National Government’s GDP growth target of 7.0-8.0 percent for the next three years. 

Supporting our positive outlook in the economy is our robust external position.  Our gross international reserves (GIR)  provide adequate buffers from global headwinds and the economy’s key external debt indicators continue to show improvement. 

The end-December 2018 GIR level of US$79.2 billion continues to serve as an ample external liquidity buffer as it is equivalent to 7.0 months’ worth of imports of goods and payments of services and primary income.  It is equivalent to 5.8 times the country’s short-term external debt based on original maturity and 4 times based on residual maturity. 

Citing figures as of September 2018, our external debt-to-GDP ratio remains favorable at 23.5 percent.  The country’s external debt also remains largely medium- to long-term in nature at 82.4 percent of total external debt.  This means that FX requirements for debt payments are well spread out and, thus, more manageable.  Additionally, our debt service ratio (DSR), which measures the adequacy of the country’s FX earnings to meet maturing debt obligations, has remained single digit (6.3 percent as of end- October 2018) and well below the international benchmark range of 20.0 to 25.0 percent.

 The country’s liquidity and credit conditions remain healthy.  These generally reflect the favorable outlook of our economy and continuous deepening of our financial market.

Sustained expansion of economic activities has led to increased demand for loans across key economic sectors.  This is reflected in the continued expansion of bank lending with loans diversified across production sectors.

The continued strong credit activities also demonstrate the effectiveness of Philippine banks in their role as intermediator of funds in the economy.

The country’s expanding productive capacity, borne by years of structural reforms, also reinforce our economy’s growth momentum.

Current estimates using various methods indicate potential output growth ranging between 6.5 – 7.0 percent. This is consistent with the medium-term growth target of 7.0 – 8.0 percent.  The rise in the country’s potential output has been attributed to the: i) improved economic efficiency as indicated by the declining incremental capital-output ratio; ii) increasing total factor productivity; and iii) favorable labor market dynamics given the young population and improvements in the education and skill sets of those in the labor force.

The government’s thrust toward accelerating productive investment in physical and human capital is expected to generate positive spillovers on private investment and improve productivity anew over the medium term.

Meanwhile, the government’s strong commitment toward the implementation of its massive infrastructure agenda – the Build, Build, Build program – is also expected to raise the economy’s growth potential. The “Build, Build, Build” program is envisioned to generate an “impressive multiplier effect” on the economy – increasing the productive capacity of the economy, creating jobs, increasing incomes, and strengthening the investment climate leading to sustained inclusive growth.

There is also the demographic aspect of the Philippines that is waiting to be maximized.  Our population is young and vibrant … one of the youngest populations in the world! --- which can provide a steady stream of capable labor to fast-growing industries.

The Philippines’ solid macroeconomic fundamentals and growth prospects are affirmed by the continued favorable investor sentiment in the country.

From January to October of 2018, FDI inflows grew by 1.8 percent from the comparable period in 2017.  Latest data (Q3 2018) also reveal that our FDI-to-GDP ratio has registered higher figures relative to our neighboring countries.  We expect FDI to further receive a boost following the release of the government’s 11th Foreign Negative List last October where foreign ownership is now allowed in certain areas and activities that were previously disallowed to them.1

Portfolio investments likewise recorded net inflows for the first three quarters of 2018, a reversal of the net outflows recorded for the same period in 2017.

In 2018, credit rating firms also recognized the sustainability of the Philippines’ favorable economic performance, as affirmed by their continued investment grade rating for the Philippines.

Against this macroeconomic backdrop, the Philippine banking system sustained its growth story and continues to operate in a safe and sound manner despite lingering volatilities in the global financial markets.  
The Philippine financial system, with the banking sector at its core, continues to be a source of strength and stability for our economy. The asset base of the banking industry had reached Php16.4 trillion as of end- November 2018.  Loan quality remains satisfactory amid continued loan growth as banks continue to adhere to sound credit underwriting standards. Moreover, banks remain well-capitalized, with capital ratios remaining well above domestic and international regulatory thresholds. 

The positive outlook on the domestic banking system is affirmed by the results of the maiden report of the Banking Sector Outlook Survey (BSOS) released last year.  About two-thirds of the surveyed Presidents, Chief Executive Officers, and Country Managers of the banking sector perceive a stable outlook for the banking system. The remaining one-third view that the banking system will be stronger in the next two years.

Ladies and gentlemen, even as our economy and financial system remained resilient in 2018, the BSP continued to implement reforms to promote more effective monetary operations and improve the transmission of monetary policy, fortify the banking sector, and promote the continued prudent risk-taking of supervised financial institutions.

First, to enhance the Interest Rate Corridor (IRC) system, we introduced several refinements, including changes in the timing of daily RRP operations and announcement of weekly term deposit facility (TDF) auction offer volumes, additional tenor offered in the TDF, and adjustments in the term deposit auction offer volume when necessary. These enhancements align the conduct of BSP’s monetary operations with international central banking practices, encourage active and dynamic liquidity management by banks, and afford the BSP with sufficient operational flexibility.  With the resulting firm anchoring of market rates to the IRC, we were likewise able to pursue bold structural reforms.  As operational adjustments, we reduced reserve requirements ratio by a total of 200 basis points in 2018, in line with our phased and gradual approach of reducing RRR to single-digit level over the medium term.   There is scope for further reductions even as we see inflation path returning firmly within the target and inflation expectations stabilizing.
Second, to continuously ensure financial stability, the BSP introduced a number of micro and macroprudential measures.  As part of the Basel III framework for liquidity and capital standards, the Monetary Board approved adoption of the Net Stable Funding Ratio (NSFR) and Countercyclical Capital Buffer (CCyB) for universal and commercial banks (U/KBs). The BSP likewise required banks to submit more granular reports on their real estate exposures to aid the BSP in crafting more informed and calibrated policy decisions in areas that require careful supervisory action.

Third, to promote financial deepening, the BSP implemented measures to further develop the domestic capital and foreign exchange (FX) markets.  These include enhancement of rules for bank issuance of bonds and commercial papers, effectively easing access to the capital markets by banks resulting in more depth in the private bond market.  We have also further liberalized FX rules and pursued improvements in the governance framework of the FX trading market to ensure a more organized market supportive of a flexible and market-determined exchange rate.  As part of this reform agenda, we endorsed the establishment of a local Renminbi (RMB) trading market.  The memorandum of agreement signed by the RMB community allows market participants to be involved in the rule-making process, thereby enhancing the governance and transparency in the market.  The established US/PHP FX trading market will be similarly organized.  Soon, the BSP will likewise issue a circular on the FX market governance framework, formalizing policies that promote fair, liquid, and transparent FX market to ensure that market participants transact at competitive prices in a manner that conform to BSP regulations and internationally accepted standards.

Fourth, the BSP took significant steps to raise the efficiency of the payment system.  The Memorandum of Agreement (MOA) signed by the BSP and the Philippine Payments Management, Inc. is expected to strengthen the governance of the retail payment industry. Last year, the BSP also launched InstaPay, the latest automated clearing house (ACH) under the National Retail Payment System Framework.  InstaPay’s launch comes on the heels of the first ACH, PESONet, initiated in November 2017. In line with these, the BSP considers the enactment of the National Payment Systems Act in October vital to the country’s payment systems development agenda. 

Fifth, the BSP carried out meaningful initiatives and partnerships to advance financial education and inclusion, and consumer protection.   Among these, the BSP signed a MOA with the Department of Education and BDO Foundation to develop financial literacy tools to support financial education in the K to 12 curriculum. A MOA was also signed with the Department of Trade and Industry, Microfinance Council of the Philippines, Inc., and Alliance of Philippine Partners for Enterprise Development, Inc. to expand the financial services available to the micro, small and medium enterprises (MSMEs) served by Negosyo Centers.  Just before 2018 ended, the BSP established the Center for Learning and Inclusion Advocacy to help reinforce a regulatory environment that encourages delivery of innovative, responsive, and sound financial products and services.  Through the initiative of the BSP, the First Financial Education Stakeholders Expo was also held in 2018. Meanwhile, to further consumer protection, the BSP approved the regulations that implement the Philippine Credit Card Industry Regulation Law.

Ladies and gentlemen, I have shared good news with you, but still I will be remiss if I do not mention that 2019 comes with some imminent risks, of which we remain vigilant.

On the external front, the US Fed is expected to pursue further gradual increases in the Fed funds rate and balance sheet reduction.  While authorities have emphasized flexibility in monetary decision making, the continuation of the US Fed’s tightening cycle may contribute to financial market volatility and spill over to emerging markets through capital flow reversal, exchange rate and asset price pressures, and in general, tighter financial conditions.  Nevertheless, ongoing monetary policy communication efforts from the US Fed are expected to play a key role in reducing the possibility of abrupt market responses. The threat of geopolitical tensions also remain.  

On the domestic front, weather disruptions, exchange rate pressures due to continued importation of capital goods in support of the administration’s investment in infrastructure and the policy normalization of the US, and rising corporate leverage amidst the global tightening cycle warrant close monitoring. Delays in addressing the country’s infrastructure gaps are likewise possible. 

Although the deficits of the fiscal account and current account can be accounted for by higher public investment, we must remain vigilant and guard their sustainability.  There is also those that say our economy might be overheating, particularly citing our credit growth.  However, we must recognize that the credit growth in the country is driven not only by consumption, but more importantly by investment activities which boost the economy’s productive capacity. As such, we expect growth in demand to be continually and sufficiently matched by rising supply, resulting in more manageable and low inflationary pressures moving forward.

Ladies and gentlemen, this year we are celebrating 70 years of central banking in the Philippines.  As we reflect on what transpired in the past year, we remain mindful of the fact that the policy actions and decisions of the BSP have the capacity to shape the economic fortunes of our nation, and therefore hold firm to our commitment to the BSP’s primary mandate of price stability.

Amidst all the risks and challenges that are forthcoming, the BSP cannot promise an easy road ahead. What the BSP promises is that it will keep a watchful eye on domestic and external conditions to ensure that its monetary policy framework remains responsive to the very fluid economic environment.  We will continue to maintain sufficient buffers to shield the economy from adverse shocks.  We will continue to enhance our stress tests, early warning tools, and micro and macroprudential policies to ensure that the financial system remains innovative, stable, and supportive of economic growth. We will continue to undertake bold and purposeful reforms to make the financial system more efficient, dynamic, and truly inclusive.

The BSP shall stay on track and carry out its mandates of price stability, financial stability, and efficient payments and settlements system.

I sincerely wish you all success, peace and prosperity this new year! 

1 The 11th Foreign Investment Negative List was signed on 29 October 2018.  The 5 investment areas and activities that can now be 100% owned by foreigners are the following: (1) Internet businesses, (2) Teaching at higher education levels provided the subject being taught is not a professional subject, (3) Training centers that are engaged in short-term high level skills development that do not form part of the formal education system, (4) Adjustment companies, lending companies, financing companies, and investment houses, and (5) Wellness centers.  Other major changes include allowing foreigners to own up to 40% of contracts for the construction and repair of locally-funded public works, except for infrastructure or development projects covered in Republic Act No. 7718, and projects which are foreign-funded or assisted and required to undergo international competitive bidding. Forty percent foreign ownership has also been allowed for private radio communications network sector from 20% before.