I would like to greet everyone a very good morning at this forum organized by the Foreign Correspondents Association of the Philippines. I would also like to take this opportunity to thank the media support extended by FOCAP in all the years in my government service and as Governor of the BSP. You have continued to be a major provider for the information needs of the international business community with regard to the Philippines as well as a forum for encouraging economic policy discussions.
As we usher in the year of the rooster, many in the Chinese communities all over the world believe this will be a more stable and prosperous period. This may be holding true for the Philippines. From how we have hit the ground running in 2005, we have recently seen marked return of investor confidence as seen through the rapid strengthening of our PhP/$ exchange rate that has breached both the 56 and 55 level, increased activity in our stock exchange, reasonable borrowing costs from our recent global and domestic bond issuances as well as Calpers retaining us in their investment list.
Although this is not just by chance or determined by astrologers, it has clearly shown that our sound economic management is working. This is quite evident as we achieved a more broad-based economic growth in 2004 and note, the strongest in 15 years. We have regained control over our public finances anchored on strict fiscal discipline. We have attracted robust capital inflows from investors and remittances from our OFWs that have led to the highest ever in our FOREX reserve level.
Putting things in perspective, this begs the question: Is this sustainable? It is in this area that I would like to highlight our reforms to strengthen the financial system, particularly on capital market development. Looking at our existing capital market fundamentals, much remains to be desired. We note that our savings to GDP ratio is low at 21% while our Asian neighbors are attaining an average of 38%, mirroring in their robust economic growth. Likewise, the depth of our financial system as seen through M2 to GDP ratio is shallow compared to the region. These are on account of the high intermediation cost that has created a big gap between savings and loans. Meanwhile, government papers dominate over 90% of the capital market thereby offering little or no alternative instruments. Also, capitalization of our equities market is small in comparison with the region.
The need to further strengthen our financial system, hinged on a healthy banking system and a well-functioning capital market, is a prerequisite in laying-out one of the strong foundations for realizing sustained growth and development for our country in the long-term. A healthy banking system with a deep capital market can effectively and efficiently mobilize savings and distribute these to growth enhancing investment projects. In essence, a robust financial system will make an economy less vulnerable to expectations that a financial crisis will happen in view of real economic disturbances and more resilient when a financial crisis does actually occur.
A critical area of basic reform to support this endeavor is our shift to inflation targeting that has greatly steeled our resolve and increased our transparency. By pre-committing to a specific inflation target range, we are in effect committing ourselves to maintain financial discipline. Otherwise, the inflation targets will not be credible. On the other hand, credible inflation targets lead to greater financial stability. Disclosure on the conduct of our monetary policy such as on how we arrived at our policy decisions will further assist us in our ability to maintain a more predictable and stable environment. This is a necessary condition to jumpstart progress in the capital market.
The resiliency of the banking system amidst the 1997 financial crisis and the fallout it created in the economy in its aftermath can be attributed to various reform measures that were pushed by the BSP prior to the crisis. We have continued to build upon these past reforms to further strengthen the foundations of our banking sector. The BSP’s banking reform agenda thrusts remain centered on facilitating the restructuring of the local banking system through asset clean-up; strengthening corporate governance and transparency mechanisms; the adoption of prudential regulations that are aligned with international standards; and more effective enforcement of prudential standards.
To stimulate and improve the local financial market, we have supported the establishment of critical market infrastructure to enhance system integrity and overall market confidence. We have developed and put into operation a world-class payments system called PhilPaSS that is playing a key role in the safe and efficient settlement of large payments including those associated with the trading of government securities and foreign exchange. We have supported the private sector initiative creating the fixed income exchange that will foster a more efficient and transparent trading of debt securities in secondary market. We are now implementing a third party custodianship process that will ensure the proper delivery, accounting and monitoring of all securities sold.
We have also modified regulations to support the local capital market. We encouraged banks to issue long-term instruments such as unsecured subordinated debt that qualify as tier-2 capital and long-term negotiable certificates of time deposits. We have lowered reserve requirement from 19% to 2% to allow banks to engage in documented repos to further deepen market liquidity as well as to invest in innovative financial products that include structured debt, collateralized debt obligations, and credit derivatives to allow for greater portfolio diversification. Recently, we have started reforms in the trust business such as implementing regulations that will gradually phase out common trust funds to pave the way for unit investment trust funds that better reflect market prices and are not subject to reserve requirement. This is expected to further develop the institutional investor base to support a more active capital market.
As the financial market is increasingly becoming complex and innovative, the BSP has played an active role in building a stronger consolidated supervision mechanism among the key regulators of the financial system. One such initiative is the creation of the Financial Sector Forum last year, composed of the BSP, the SEC, the PDIC and the Insurance Commission.Our coordination efforts to address issues on harmonizing supervisory and regulatory concerns, strengthening of the exchange of information among the different regulators and promotion of better consumer protection will be in full stride this year and in the near term.
To complement our reform measures, we have assisted in the enactment of key laws that will accelerate progress in the capital market that include the removal of the documentary stamp tax in secondary trading of securities; the SPV Law; and Securitization Law. But more remains to be done. We are currently prioritizing the approval of amendments to the BSP Charter that will provide our personnel sufficient policing powers and improve their legal protection; and the creation of a credit information system, featuring a central credit information bureau, that will boost the flow of borrower information. This will result in lower intermediation and borrowing costs while increasing access to credit of small borrowers. We are also supporting other vital legislation such as the Corporate Recovery Act, the revised Investment Company Act, the Personal Equity Retirement Account Act and the Pre-Need Code that will all significantly boost the development of the capital market.
It is a mistake to ignore the poor in building a financial system. With estimates that almost half of our economy is driven by the informal sector, imagine the momentum of growth and productivity they can bring if we are able to move them in the so-called formal sector. One such avenue is to support and broaden the access of the poor to financial services. An initiative in this direction, our flagship program on microfinance, has quickly borne fruit. Today, our banks, especially rural banks, have an outstanding loan portfolio of more than Php3.2 billion dedicated to microfinance, benefiting over half a million very small entrepreneurs.
All these reforms should gradually improve our financial system fundamentals and move us at par with our fellow Asian countries. It is very critical that the recent gains from our reform initiatives should not make us lose our focus or be lulled into complacency, as these will only lead to slowing down or worse, wiping out the current progress we have built. We need to continue to do the right things we have been doing and change things that do not work for us. The tides of change are in motion and with your help and support should keep it running its due course.
Thank you and a pleasant day ahead for us all.
(Note: Foreign Correspondents Association of the Philippines, 14 February 2005, Mandarin Hotel, Makati City)