Tax reforms positive for PH, but may force BSP to raise rates

Japanese financial giant Nomura expects the Philippine economy to benefit from the Duterte administration’s recent enactment of tax reforms, thanks to the boost provided by an infrastructure build-up program which the new law will fund.

At the same time, however, its analysts predicted that the resulting uptick in prices—as much as a 1-percentage point rise in the inflation rate by the end of this year—would force the hand of the Bangko Sentral ng Pilipinas to raise interest rates for the first time since 2014.

“We maintain our inflation forecast from the total impact of the tax reform, taking full-year 2018 inflation to 4.3 percent from 3.2 percent,” Nomura said in its study published last week. “This is broadly in line with BSP’s claim after passage of the legislation the impact on headline inflation will be ‘less than 1 percentage point’ and the House of Representatives’ preliminary estimate of 0.85-1.2 percentage point.”

Nomura noted that the smaller increase in diesel tax, the dilution in car taxes and value-added tax (VAT) exemptions “represent a reduction of the impact” compared with their baseline assumptions, while the introduction of the coal tax and the increase in cigarette taxes “provide an offset.”

“We believe the risks around our forecast are to the upside because of the coal tax, which we expect to ultimately be passed on to consumers and raise electricity rates,” it added.

This will prompt the central bank to take a preemptive move against rising prices that threaten to breach its forecast range of 2-4 percent for 2018 and respond with a cumulative 100-basis point increase in interest rates, broken down into a 25-basis point hike for every quarter of this year, Nomura predicted.

That would bring BSP’s key overnight borrowing rate to 4 percent from the current 3 percent and also raise borrowing costs across the domestic economy correspondingly.

“In 2014—the last time BSP hiked rates—it was all about inflation risks, with the rate hikes described by BSP as a ‘preemptive response’ to the balance of risks around inflation experiencing ‘a further upward shift’ and putting the target at risk,” Nomura said. “We believe demand-side pressures are even stronger today than in 2014 and thus inflation expectations are also likely to accelerate amid supply-side increases from oil prices and tax reforms.”

Nonetheless, Nomura noted that the tax increases reinforced its positive view on the Philippine economy “anchored, in part, on the timely enactment of such a major piece of legislation.” —DAXIM L. LUCAS