Rising risks to economic growth and rate cuts elsewhere are likelyto prompt the BSP to take its policy rate a little lower still4 But the end of the rate easing cycle is near, with a perk-up inFebruary inflation pointing to lingering risks to price stability4 Exchange rate volatility will come to dominate BSP thinking onrates, with caution prevailing and hikes on the table as well
Ample liquidity provides a buffer
It has been a remarkable ride for the Philippines. While the world'sfinancial system slid into a desperate scramble for dollars, the countrycoolly stood by, registering little impact on the value of its currencyand, as of yet, on economic growth. This, it needs to be said, is a far cryfrom the past, when an unhealthy penchant for deficit spending, financedmore often than not by dollars, periodically put the economy in a tightspot. By these standards, as well as by the contemporary standards ofmarkets elsewhere, it has been remarkably smooth sailing for thePhilippines. We have long argued that things will get a little bumpier forthe country over the course of this year, not least because remittances areyet to register the full impact of collapsing growth elsewhere. But,despite a slump in growth and peso volatility, we cannot quite find thepressure points that plagued the Philippines in the past.
Which brings us to the central bank. The fact that the BSP cut rates ratheraggressively to a record low in this environment of dollar shortage istestimony to the benefits of its newfound fiscal stringency, as well as itsreasonably robust external payments position. But, as impressive as theseadvances are, the central bank may not necessarily have room to take ratesmuch lower. As we argue elsewhere (see Peso Pressure, 4 February 2009), andagain in this report, the central bank needs to guard against potentialexchange rate volatility. To be sure, the risk for now is not so much thata falling peso would lead to a crushing burden of external debt payments, apainful process that the country has had to grapple with in the past.Rather, it is that a depreciating peso may stoke price pressures.
Already, in February, headline inflation has perked up. Yes, globalcommodity prices are falling and everyone is keeping a sharp eye ondeflationary tendencies elsewhere. But the CPI in the Philippines is farmore sensitive to the exchange rate than anywhere else in Asia, leaving theBSP no room to sit idly by as the peso slides against the dollar. In short,we expect the policy rate to drop by another 50bp to 4.25%. But the endlooks near as caution starts to prevail. Luckily for the Philippines, thereis currently no real need to push rates lower as liquidity remains ample.At long last, there are enough pesos to finance spending...
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