Three hikes and a Trump presidency: How PH can withstand economic pressures

Monetary authorities in the United States are eyeing up to three interest rate hikes this year amid jitters currently dogging a Donald Trump presidency.

Last Dec. 14, the policy-setting Federal Open Market Committee unanimously voted to raise the key federal funds rate to the 0.5-0.75 percent range. This was only the second time that US interest rates were increased in the last 10 years, with the last action in December 2015.

US Fed officials expect three more hikes to bring the rate to 1.4 percent by end-2017, as Trump’s promises to jack up infrastructure spending while slashing taxes were seen to grow inflation faster.

In its medium-term development blueprint, President Duterte’s administration acknowledged the risks coming from these looming US Fed rate adjustments.

“The recent pronouncement of the US Fed to hike the fund rate can have repercussions on the sector in the medium- to long-term. This will have an implication on the borrowing costs of the country. The same implications result from the depreciation of the currency,” the draft Philippine Development Plan (PDP) for 2017-2022 read.

In a recent speech, Bangko Sentral ng Pilipinas (BSP) Governor Amando M. Tetangco Jr. said local monetary authorities would have to be on alert.

He said if the Fed veered away from plans for three hikes, volatility in both the global and domestic foreign exchange and fixed income markets could rise. So would a steeper than expected rate hike, he added.

“Such price movements may adversely affect the balance sheets of domestic corporates and banks, especially of those that have foreign exchange and floating interest rate obligations. This adverse result would be magnified if the markets panic, overreact, and thus amplify the initial increases in interest rates and weakness of the peso,” he said.

He said a tightening in domestic financial market conditions may also weigh on domestic credit activities, especially in the near term.

“However, if the reason for Fed tightness is that the underlying US economic growth has become stronger, then that may offset some of the near-term negative impact of the Fed tightening and lead to overall support for global growth in the medium term,” according to Tetangco.

“On the other hand, if the Fed turns dovish (in effect, fewer or no further hikes in 2017), then that could encourage risk on market behavior, stall domestic interest rate increases and dampen depreciation pressures in emerging markets. But such result is unlikely, as Trumponomics, which is reported to focus on increased fiscal spending, is widely expected to be inflationary,” Tetangco added.

In its latest report on inflation released this month, the BSP said the country’s economic fundamentals were strong enough such that it could withstand and even overcome external shocks. He cited the adequate domestic liquidity and the government’s bid to reform its fiscal direction.

“Moreover, in the near term, policy settings and the resulting overall monetary conditions remain appropriately supportive of economic activity. At the same time, it provides scope for flexibility in view of continued uncertainty in the global economy,” the BSP said.

In December, the Monetary Board—the BSP’s highest policy-setting body—kept key rates steady while also maintaining the 2-4 percent inflation target for the next four years.

This latest decision was anchored on expectations that “domestic demand conditions are likely to stay firm, supported by solid private household spending, higher government expenditure, and adequate domestic liquidity” in the near term, Tetangco said.

He said the BSP currently has a “deeper” policy toolkit that contained economic buffers. These include: Macroprudential regulations that can be targeted to specific sources of risks, contingency measures such as liquidity-enhancing facilities, and rediscounting windows and regional firewalls that boost the flexibility and effectiveness of its actions.

“In terms of supervision, we continue to review and align our financial regulations and policies with international standards to improve risk management as well as ensure the competitiveness of our banks in view of Asean integration,” the BSP chief said.

Domestic political noise

Besides the expected US Fed action, Tetangco pointed to two other risks seen to affect the Philippine economy—soft global growth coupled with looming protectionism, as well as domestic developments, including politics.

He said China has always been a concern. “As you know, China has moved away from dependence on exports to more domestically oriented sources of growth such as services and consumption. While this move has helped stave off a hard landing for China, it remains to be seen whether this rebalancing is sustainable over the medium term,” Tetangco said.

The country is also on the lookout for the direction of the populist wave, which was bolstered by the United Kingdom’s exit from the European Union and the recent rise of Trump. He said both of these events have shown a leaning toward protectionist policies.

“If the shift to inward-looking policies gains traction, this can potentially further shrink global trade, which could lead to even lower global growth. In economics, this is a classic case of the Prisoner’s Dilemma, wherein because of the absence of cooperation, the simultaneous actions of economic agents lead to sub-optimal outcomes,” Tetangco warned.

These protectionist policies would greatly affect overseas Filipinos’ deployment and remittances and could cause a slowdown in the business process outsourcing sector.

While the direct exposure of the Philippines to the UK is relatively limited, “the bigger concern, however, is whether the other EU economies will follow the UK’s lead; given that our trade exposure to the EU is larger at around 12 percent,” he said.

With regard to the Trump administration, “we will need to see how his campaign rhetoric translates to actual policy,” Tetangco said.

On the local front, there would always be the political noise and the adverse weather disturbances, he added.

Meanwhile, revenues from the tax reform being bannered by the administration must not fall short of the goal, he said. “If critical infrastructures are not built on time, this could hold back the country’s current economic growth momentum.”

Robust growth

But for Tetangco, the Philippine economy, as a whole, is still expected to sustain robust growth this year.

“The economy should be able to weather 2017 relatively well barring surprises that are more surreal than those in 2016,” the BSP chief said.

The country’s third quarter gross domestic product was at 7.1 percent, making the Philippines the fastest-growing among major Southeast Asian emerging economies. Tetangco said the country has had 71 consecutive quarters of positive economic growth, which could well continue in the fourth quarter.

Tetangco said “the positive alignment between growth and inflation has been a sustained narrative.”

“Headline inflation stands at 1.8 percent for full-year 2016. While average inflation is below the government’s target range, inflation is projected to rise toward the midpoint of the target range in 2017 and 2018. In other words, inflation is seen to be manageable,” he noted.

The stable banking sector was also helping spur the domestic economy, he said.

“Our flexible exchange rate policy provides us with a tested tool to shield the economy from temporary gyrations, while our adequate reserves and sustained current account surplus fundamentally anchor our external position,” Tetangco added.

In a recent economic bulletin, Finance Undersecretary Gil S. Beltran said “maintaining good macroeconomic fundamentals is the best way to keep the local interest rates down as the US Federal Reserve raises its key policy rate.”

Beltran, who is also the Department of Finance’s chief economist, said in a report to Finance Secretary Carlos G. Dominguez III that “the Duterte administration has the capacity to dampen the effects of the impending normalization of US interest rates.”