MANILA, Philippines—The steep rise in foreign capital inflows had put the liquidity management skills of the Bangko Sentral ng Pilipinas (BSP) to the test in recent months.
The price pressures brought about by the significant inflows of “hot money,” composed of short-term investments largely in stocks and money market placements, required unconventional means to tame inflation.
The BSP’s goal is to help ensure that inflation for this year and the next stays within a range of between 3 and 5 percent. To stem price increases, monetary authorities normally hike interest rates. An increase in the central bank’s key policy rates influences commercial interest rates, making loans more expensive, thereby tempering borrowing demand. Consequently, purchases supported by loans, and thus inflation, tend to slow down.
The need to fight price pressures created by consumers’ rising demand was the reason why the BSP hiked its key policy rates twice in the first half of the year, each by 25 basis points.
The key rates now stand at 4.5 and 6.5 percent for overnight borrowing and lending, respectively.
But BSP Governor Amando Tetangco Jr. said the inflow of foreign portfolio investments—which started to rise last year and became more pronounced this year—had complicated the regulator’s conduct of liquidity management and inflation control.
Tetangco said that while raising interest rates would usually suffice in taming inflation, the same could not be said when price pressures were caused not only by normal spike in demand but also by rising inflows of “hot money.”
This is because higher interest rates can actually attract more foreign portfolio into the country, resulting in a buildup of additional liquidity that can lead to higher demand and accelerate the rate of rise in consumer prices.
Taxing capital inflows
The problem posed by rising foreign capital inflow is not peculiar to the Philippines. Investors turned to emerging markets, and away from poorly performing industrialized economies, to invest in securities that offered little risk.
From January to August, the amount of foreign portfolio investments that came in reached $3.1 billion—up 230 percent from the $926 million reported in the same period last year.
While the inflow of foreign capital should have been a welcome development, too much of it could trigger price pressures and spell trouble for the economy, monetary authorities had said.
The inflationary pressures arising from these flows have prompted central banks of other emerging economies, such as Brazil, to adopt the drastic measure of slapping taxes on foreign portfolio investments.
Taxation of capital flows used to be frowned upon by the international community, including the International Monetary Fund (IMF), because such a move runs counter to the concept of free flow of capital.
But the IMF has since taken a different tack. It now approves of such restrictions on huge inflows, to temper the inflationary problems that go with it.
So far, the Philippines has seen no need to impose constraints on the inflow of hot money. The BSP said such a move could lead to a massive outflow of capital—something the country would not want to experience.
Also, the BSP has other ways to deal with inflation. It raised the reserve requirement for banks twice this year for a total of 2 percentage points. The reserve requirement, which determines the amount of deposits banks must keep as reserves with the BSP, now stands at 21 percent.
The reserve requirement in the Philippines is already quite high compared to many other countries where the requirement averages just below 10 percent. This is the reason why the BSP was hesitant at first to raise the reserve requirement further. But the high levels of hot money forced the BSP’s hand.
Within target
“The Monetary Board [of the BSP] is of the view that sustained foreign exchange inflows, driven by upbeat market sentiment over the brighter prospects for the Philippine economy, could fuel a further acceleration of domestic liquidity growth that could pose risks to future inflation,” the BSP said in a statement released immediately after it raised the reserve requirement for the second time this year.
With a higher reserve requirement, the BSP said, the amount of liquidity circulating within the economy would be tempered without having to raise interest rates.
The BSP said it also implemented some “macro-prudential measures,” or bank regulations, to help ease the impact of hot money on inflation. These measures include limits on the amount of real property loans banks may extend to help ensure that huge liquidity in the system will not translate to a steep rise in the prices of properties.
In the first nine months of 2011, inflation averaged at 4.3 percent. The BSP expects it to stay below the 5-percent ceiling this year and the next.
It is important for monetary authorities to keep the lid on inflation if they wish the country to attain its economic growth target.
In September, the Philippines saw a reversal of the trend of rising capital flows. Economists said this was due to the prolonged debt crisis in the eurozone, which discouraged portfolio fund owners from undertaking unnecessary risks.
The unresolved crisis in the eurozone is expected by many to dampen growth of emerging economies, prompting investors to pull out their funds, preferring to stay liquid.
Outlook on ‘hot money’
In September, net inflow of foreign portfolio investments, led by equities, dropped by 62 percent to $150 million from the $394 million reported in the same month last year. It was the first time this year that the flow of foreign hot money registered a year-on-year decline.
“The decline reflects the bearish sentiments of the market with the continuing debt crisis in the euro zone,” the BSP said in a report.
BSP Deputy Governor Diwa Guinigundo said a “partial reversal” of the flow in foreign capital was actually welcome because it made the conduct of monetary policy less complicated.
Tempered inflows make the task of liquidity management easier, Guinigundo explained.
But the BSP does not expect inflows to remain moderate.
According to Tetangco, the aberration is likely to be temporary, and inflows of foreign portfolio investments are likely to surge again soon, particularly after European leaders and banks on the continent have struck to contain the debt crisis in the euro zone.
Once global financial markets begin to calm down with the expected resolution of Europe’s debt woes, portfolio fund managers will again flock to emerging markets like the Philippines to purchase stocks and other securities, he said.
“The turmoil in the eurozone will be temporary. Once it is resolved, emerging markets like the Philippines will again attract more inflows because their growth prospects are more favorable [than those of industrialized countries],” Tetangco said.
Given this projection, the BSP stands ready to implement measures and make sure that inflation will not go over the top due to a surge in hot money inflows, he said.