Continuity & Consistency

A smooth, seamless transition at the Central Bank

By Amando M. Tetangco Jr.

Assuming his post as the new Bangko Sentral ng Pilipinas governor in July 2005, Amando M. Tetangco Jr. promises to deliver price stability through inflation targeting and to continue with reforms in the financial system. Following are excerpts of a speech he delivered before the Makati Business Club and the Jose B. Fernandez Center for Banking and Finance of the Asian Institute of Management on 22 July 2005.

Growth Despite Costly Oil

The sustained period of high oil prices has triggered adjustments in transport fares and nominal wages. We have also been affected by the El Niño dry spell which led to higher agricultural prices. Despite all these shocks, however, real GDP expanded at 6.1% in 2004, and managed to grow at 4.6% in the first quarter. Growth in private consumption remains the lynchpin of domestic demand, bearing up against the effects of higher oil prices and a soft labor market. In addition, headline inflation has stabilized in the past few months at 8.5%. In June, it went down to 7.6%. Core inflation also slowed down in June.

The BSP has remained focused on preventing a further build-up in price pressures while remaining supportive of domestic demand. We have largely refrained from raising our policy interest rates over a longer period in the view that monetary tightening would reduce demand. It was also important to allow demand to continue to grow to balance out the inevitable contractionary impact of rising oil prices.

Managing Expectations

Recently, however, the BSP saw a need to respond to the increases in wages and the public’s expectation of future inflation. On April 7, the Monetary Board raised the BSP’s policy interest rates by 25 basis points to prevent the public’s inflation expectations from spiraling away from the government’s inflation target.

Recent evidence of excess liquidity in the financial system has also raised concerns about its effects on inflation and inflation expectations. This excess liquidity also seems to have contributed to the volatility in the exchange rate, which can exacerbate inflation pressures. To mop up the excess liquidity, the BSP raised bank’s reserve requirements on July 15 by 1% each for regular reserves and liquidity reserves.

An added complication to the current environment is the impact of recent political developments and the uncertainty surrounding the value-added tax.

Reducing Soured Loans

Meanwhile, the banking sector remained stable in the first semester of 2005. Banks remained well capitalized with the capital adequacy ratio on a solo basis at 16.9% (as of end-September 2004), higher than the minimum requirement of the BSP. As of end-March 2005, total resources grew by 12% compared to a year ago, with total loans exclusive of interbank loans rising by 6.9% (as of end-May). Deposits also grew by 12% (as of end-March 2005) compared to a year ago. Asset quality, meanwhile, improved as well, with the nonperforming loan ratio falling to 10.9% as of end-May 2005. Nonperforming assets disposed through special purpose vehicle transactions reached P75.7 billion as of June 15.

Pressures Ahead

Supply-side inflationary pressures from oil prices and other sources continue to loom over the policy horizon. Among the other factors that could contribute further to pressures on domestic prices include petitions for additional wage adjustments as consumer prices rise further, sustained pressures on the exchange rate due to falling interest rate differentials and the negative perception about the government’s ability to fix the fiscal situation, and a build-up of excess liquidity in the financial system, which could equally lead to exchange rate pressures and increased inflation expectations.

Build Up Capital Market

There are also a number of risks and challenges for the BSP on the supervision front. We have made good progress in addressing the burden of nonperforming assets through SPV transactions. The greater challenge, however, is to speed up the process of asset disposal in order to bring back the banking system’s NPL ratio closer to its single-digit pre-1997 financial crisis level. Meanwhile, the adoption of Basel 2 capital standards also poses a challenge for the banking industry.

Developing the domestic capital market remains a continuing challenge for us. The Philippines’ savings-to-GDP ratio of 21% is much lower than the Asian average, and our financial system is relatively shallow compared to the rest of the region. Moreover, the capital market is dominated by government debt papers, thereby offering very little alternative instruments for saving. In addition, capitalization of our equities market is small in comparison with the rest of the region.

Follow the Mandate

The BSP’s response to these challenges are founded on the twin pillars of the BSP’s mandate. On the monetary policy front, our focus will be on addressing the risks to price stability and, over the medium term, making monetary policy work more effectively in the Philippine setting. On the supervision front, our task will be to push for further reforms to ensure a healthy and strong banking system and a well-developed local capital market.

In addressing risks to inflation, the BSP will continue to adhere to inflation targeting as its approach to monetary policy. We have made significant strides in promoting price stability in the last three years since the adoption of inflation targeting. Nevertheless, many important challenges still lie ahead, particularly in terms of enhancing our capacity to anticipate possible shocks to the economy. We need to make sure that we do not only have the right tools to deal with shocks but also that we will not be paralyzed by surprises.

To preserve the stability and integrity of the banking sector, the BSP will adopt a four-point strategy: accelerating adoption of risk-based supervision technology; promoting corporate governance reform and increasing the effectiveness of market discipline through better financial transparency; advancing capital market reform initiatives; and improving the regulatory framework and its implementation.

Finally, some of our reform efforts require legislative support: special purpose vehicle (SPV) extension, amendment of the BSP charter, credit information bureau (CIB) bill, revised investment company act (RICA) and personal equity and retirement account (PERA) bills, revised bankruptcy act, and financial transaction bills.

Carry On Reforms

The gains that we have achieved so far, in terms of economic performance and structural reform, remain intact. Our task now is to preserve these gains and build further on them through sustained reforms. We intend not only to continue to focus on delivering price stability in the medium term through inflation targeting, but also continue the reform process in the financial system to stimulate long-term investment to better cushion the economy from adverse shocks, and support long-term sustainable growth.