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Tuesday, December 02, 2008

Will the BSP cut policy rates?

Romeo Bernardo & Marie-Christine Tang

Nine out of 10 bank treasurers polled by a local newspaper forecast no change in policy rates when the Monetary Board meets this Thursday. The rationale for the majority view seems to be that with the two-percentage point reduction in banks’ reserve requirements effective last November 14, monetary authorities are likely to keep watch of developments first before taking further action.

While that may well be the case, the policy debate within the Bangko Sentral ng Pilipinas (BSP) can be expected to be less straightforward. The talk in banking circles is that there are two points of view within the BSP/ Monetary Board. On one side is the view that policy rates need to stay put as inflation remains a threat (core inflation is after all still rising), especially with the continued weakening of the peso. On the other side is the fear that failure to ease monetary conditions, via a 25bp cut in the policy rate, may prove harmful to banks in the first instance, especially those with liquidity constraints. Down the road, given a looming global recession, the economy may be affected as well.

The latter view has been a major worry since the Lehman collapse. This may be gleaned from the various measures implemented by the BSP over the past month (Table 1) to ensure smooth liquidity flow in the financial system. Although market risk has receded somewhat in recent weeks following the recovery in asset prices, credit risk may emerge as a concern in the future as corporates (including real estate firms exposed to risks of project completion and insufficient demand) are seen to face tougher times from slower growth while banks are expected to tighten credit standards.

Already, analysts are looking at big corporates with large foreign exchange-denominated liabilities that are contending with roll-over risk.
That said, we tend to side with the view that now may not be the best time to cut interest rates.
Quite apart from firm liquidity growth (M3 grew 13.5% in September vs. 9.8% in August), we think that the BSP will be wary of actions that may cause the peso to depreciate more. From a high of P40.36/$ in February this year, the peso has depreciated to nearly P50/$ in recent trading. Already, BSP dollar sales to temper the peso’s fall (due to capital outflows driven primarily by the global liquidity crunch) has reduced its swap position from over $13 billion at the start of the year to just $2.7 billion as of end-September. Moreover, its official reserves have dropped by $1 billion to $35.7 billion in October such that a smaller BOP surplus (vs. the $2 billion projected by the BSP) is expected for the year.

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