Instead of rate cuts, BSP may reduce banks’ RRR

MACTAN, Cebu — The Bangko Sentral ng Pilipinas (BSP) might reduce banks’ reserve requirement ratio (RRR) as an alternative to loosening monetary policy, its governor said on Tuesday.

As inflation settles within the 2-4% target by January next year, BSP Governor Felipe M. Medalla said market players might now wonder when the central bank would begin slashing policy rates.

“My answer is, how can we cut if the policy rate difference between us and in the US is already very low?” he said during a financial stability conference. “We must have other ways of loosening monetary conditions even if we cannot cut rates. The easiest thing to do is to cut back the reserve requirements.”

Mr. Medalla said it would be dangerous to cut policy rates faster than the US Federal Reserve because the peso might further depreciate against the dollar.

The US Federal Reserve has hiked borrowing costs by 500 basis points since March last year, bringing the Fed funds rate to 5-5.25%. Market players are expecting the Fed to start keeping rates on hold at its next meeting on June 13-14.

The Philippine central bank has raised the key policy rate by 425 bps to 6.25%, a 100- to 125-bp interest rate difference with the US Fed.

A cut in banks’ reserve requirement is a move intended to be an operational adjustment to facilitate the BSP’s shift to market-based instruments for managing liquidity in the financial system, particularly the term deposit facility and the BSP securities.

The BSP earlier committed to bring down the ratio for big banks to single digits by this year.  The ratio for big banks is 12%, one of the highest in the region. Reserve requirements for thrift and rural lenders are 3% and 2%, respectively.

“We have been waiting for the RRR cut as it improves cost effectiveness for banks,” China Banking Corp. Chief Economist Domini S. Velasquez said.

In March 2020, the central bank cut the RRR, or the percentage of deposits and deposit substitutes banks must keep with the BSP, by 200 bps to 12% to cushion the impact of the coronavirus pandemic.

“We understand that there are timing issues under a monetary tightening environment when delaying the RRR cut. When it happens, possibly in the third or fourth quarter, it will provide liquidity to boost the economy,” Ms. Velasquez said.

A cut in banks’ reserve requirment is very likely to happen this year, Bank of the Philippine Islands (BPI) Lead Economist Emilio S. Neri, Jr. said in an interview.

He noted that the BSP might shore up its reserves before cutting policy rates.

“If the US starts cutting, then portfolio flows will reverse towards emerging markets. This is the best time to rebuild your buffers,” Mr. Neri said.

Gross international reserves (GIR) stood at $101.51 billion in April from $101.55 billion in March, based on preliminary data from the BSP.

The GIR is the amount of all foreign exchange flowing into the country. Having an ample level of foreign exchange buffers safeguards an economy from market volatility and is an assurance of the country’s capability for debt repayment in the event of an economic downturn.

“It’s hard to rebuild your buffers if you cut policy rates. The direction of capital flows will reverse if you cut immediately. Just keep it there,” Mr. Neri said. 

The Monetary Board is widely expected to pause its tightening cycle on Thursday as inflation slowed in recent months. 

A BusinessWorld poll last week showed 13 of 18 analysts expect the Monetary Board to keep rates on hold on May 18. This could be the first time the BSP will leave interest rates untouched since it began hiking in May last year.

Aside from the interest rate differential between the Philippines and the US, the country’s current account deficit might also continue to affect the movement of the peso against the dollar, Mr. Neri said.

The current account deficit was $17.8 billion last year, higher than the $5.9-billion shortfall in 2021, amid a wider trade in goods deficit.

“Imagine, commodities are much cheaper right now, but our current account deficit continues to widen,” he said, adding that this is a challenge for the government.

The current account deficit is seen to end the year at a $17.1-billion deficit, equivalent to -4% of gross domestic product. Current account transactions cover transactions involving goods, services and income. — Keisha B. Ta-asan