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IMF: Central bank needs to raise interest rates more to rein in price pressures

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By Melissa Luz T. Lopez
Senior Reporter

THE International Monetary Fund (IMF) said the central bank may need to tighten benchmark interest rates further to rein in inflation, which it described as one of the biggest risks to an otherwise “favorable” outlook for the Philippine economy.

IMF mission chief Luis E. Breuer said the Philippine economy has been “performing well” although near-term risks have increased on the back of rising inflation and a changing external environment.

IMF economists visited Manila and Bohol on July 11-25 for the Article IV mission, or their annual health check on the economy.

The delegation found that the country is likely to remain a growth leader in Southeast Asia as the group kept its 6.7% Philippine growth forecast for 2018.

Growth for 2019 was trimmed to 6.7% from 6.8% previously, with Mr. Breuer citing “tighter financial conditions” globally coupled with uncertainty from trade tensions between the United States and China.




The IMF bumped up its Philippine inflation estimate to 4.7% this year, coming from 4.2% given in April. If realized, this will surpass the 2-4% target and the 4.5% full-year forecast of the Bangko Sentral ng Pilipinas (BSP) for 2018.

Inflation averaged 4.3% last semester after hitting a fresh multi-year peak of 5.2% in June. The IMF said this was due to rising world crude prices, a weaker peso, one-off effects of tax reform and domestic demand pressures.

The central bank will have to consider “further tightening monetary policy” to douse inflation expectations, which is the biggest factor affecting overall inflation according to an IMF study.

“The BSP’s recent decisions to increase the policy rate twice were appropriate. The team welcomes the BSP’s announced readiness to take further action to safeguard price stability and continued progress in modernizing monetary operations and reforming the capital markets,” the IMF official said.

Mr. Breuer was referring to BSP Governor Nestor A. Espenilla, Jr.’s statement that the central bank is considering “strong follow-through” policy action for its upcoming Aug. 9 rate-setting meeting. This will follow back-to-back rate increases in the BSP’s May and June policy reviews, which jacked up key rates up by a total of 50 basis points (bp).

In 2019, the IMF sees inflation returning to target at 3.8%. Month-on-month inflation has lately signalled easing of price pressures in the face of tighter monetary policy, rice tariffs, stable oil prices and base effects.

As for cuts in bank reserves, Mr. Breuer said the IMF team did not detect any significant inflation impact of the 200bp reduction as the additional liquidity released has been siphoned by other tools.

“But we also noted that this has led to some communication challenges on the stance of monetary policy,” Mr. Breuer said.

“In our view, we support BSP’s intention to take stock of what has been done already and pause perhaps on further reductions on the reserve requirement until inflation is clearly on a downward path and inflationary expectations are better anchored.”

Banks are now required to keep only 18% of deposits intact, lower than the old 20% standard but still one of the highest in the world.

TAX INCENTIVES
The IMF also backed the government’s plan to overhaul tax perks given to companies, saying developing local infrastructure and human capital should help the Philippines attract more investments instead.

“The Philippines has done very well over many years and perceptions, both domestic and external, of the economy and the future are very positive. We don’t think that the Philippines needs to resort to very large tax incentives to attract private investment, whether domestic or international,” Mr. Breuer said.

“The current system of tax incentives, in our view, does not serve the country well,” he added.

“We like the idea of centralizing the crafting of tax incentives, putting the Department of Finance (DoF) in charge of revenues in a central role and then aligning these investments that the country makes to national development objectives.”

The DoF has proposed a measure that will gradually trim corporate income tax rates, but will also cut short or remove some tax perks enjoyed by firms operating here.

On the other hand, Mr. Breuer said the government should work to maintain the fiscal deficit at a level equivalent to 2.4% of gross domestic product (GDP) this year, steady from a year ago but lower than the 3.2% of GDP programmed by economic managers.

The level should also be kept for 2019 despite the three percent-of-GDP programmed deficit, with the IMF team noting that this will “support efforts to contain inflationary pressures” while sustaining the economic growth momentum.

The Duterte administration has increased its deficit ceiling to accommodate its aggressive spending plans particularly on infrastructure, which are designed to drive annual growth to 7-8% till 2022, when President Rodrigo R. Duterte ends his six-year term — well above IMF forecasts — from 6.3% in 2010-2016 under the previous administration.

On plans to shift to federalism, Mr. Breuer flagged an equal dose of risks and opportunities from devolving public funds and social services.

“Local government officials are likely to understand better the needs of the local population and to adopt public services to those needs,” he said.

“Now there are also risks,” he clarified, explaining: “[I]t is important… that transfers from the national government to the LGUs (local government units) increase comes along with a devolution of responsibilities in management of schools, hospitals, infrastructure by local government to avoid incorporating a deficit bias in the public finances of the country.”

Economic managers have expressed wariness over the proposed change in government structure amid fears that this could disrupt various projects and overall gains as more national government funds go to local units.