Defenses vs hot money surge readied

The Bangko Sentral ng Pilipinas said a surge in foreign portfolio investments, which could lead to a volatile exchange rate and accelerated inflation, is likely in the months ahead especially if the debt situation of the euro zone continues to deteriorate.

Given this scenario, the BSP said it is prepared to implement various measures to ensure stability within the economy.

“A major challenge for central banks [of emerging economies like the Philippines] is a surge in capital flows. It can cause too much liquidity in the system and pose some problems to the economy,” BSP Deputy Governor Diwa Guinigundo said.

He said that in the case of the BSP, it observes flexibility in implementing whatever appropriate measures there are to curb capital flows and manage its impact on the economy.

Last Thursday, the BSP cut its key policy rates by 25 basis points to new record lows of 3.75 percent for overnight borrowing and 5.75 percent for overnight lending.

The move, although primarily meant to support economic growth, is also seen to help temper foreign portfolio investments. The rate reduction will narrow the gap between yields of Philippine securities and US Treasuries which, in turn, gives foreign portfolio investors less incentive to invest in peso-denominated securities instead of US treasuries.

Despite the narrower yield differential resulting from the BSP’s rate cut, Guinigundo said the BSP cannot rule out the possibility of a surge in foreign portfolio investments. This is because the prolonged debt crisis in the euro zone could drive yield-seeking investors to purchase more assets from emerging markets.

Guinigundo said the BSP has a menu of measures that it can implement should there be a surge in inflows of foreign portfolio investments.

These include “macro-prudential measures” which are bank regulations that put limits on exposure of banks to certain assets. Limiting the exposure of banks, which normally transact business for investor-clients, to certain assets will help reduce overall demand for securities.

Another is the reserve requirement, which is the proportion of deposits that banks must place with the BSP as reserves. Guinigundo said raising the reserve requirement, which is currently set at 18 percent, could help siphon off excess liquidity from the economy. As a result, inflationary effects could be tempered, he said.

Guinigundo said the BSP also has the option of further relaxing foreign exchange rules. Doing so will make it easier for people convert pesos to dollars, countering the impact of foreign currency inflows.

Data from the BSP showed that foreign portfolio investments since the start of the year to July 6 registered a net inflow of $1.2 billion. This was lower than the $2.54 billion in the same period last year.