The BSP Must Stand Firm 

 The BSP is the independent body tasked by the Constitution to oversee monetary policy and regulate our banking system. It does this by controlling the supply of money, adjusting interest rates and stabilizing the peso through open market operations. In times of crisis the BSP is the last bastion for  protecting  our economy. Its independence shields it from interference by the Executive and Legislative Branches of Government.

It is therefore disturbing that in recent weeks the Executive Branch has started to speak for the BSP rather than this institution speak for itself. Thus the President announced that “the peso will be defended”. In chorus, DOF Secretary Ben Diokno chimed in stating the BSP will intervene in the foreign exchange market to the tune of $10 billion of our international reserves at a target price PHP60/USD. Diokno also said the BSP would raise interest rates by100 basis points. Sec. Diokno was the previous BSP Governor so perhaps forgot he is no longer so. There was no official reaction from BSP Governor Felipe Medalla but I would not be surprised if he was livid that others – whoever they be – are now in his lane.

Shortly after the pronouncements of the President and Diokno the peso dramatically strengthened from around P59/USD to around P58/USD, a massive move whose speed and size could only be explained by the BSP intervening in the market possibly at the behest of Malacanang. The peso rally however was short-lived with the peso quickly weakening to near previous levels. This proves that a) no institution is bigger than the market and b) currency intervention unaccompanied by economic fundamentals is unlikely to succeed. Japan’s central bank has spent $42 billion to prop the yen with little to show for it.

The U.S. is another example of what happens when a central bank succumbs to a Government’s signals to artificially stimulate an economy. Convinced that inflation was “transitory”, the U.S. Fed expanded money supply by over 25% fueling a 40 year unprecedented rise in prices. The consequent inflation has now come to haunt the Biden Administration with Democrats expected to lose control of the House and possibly the Senate in next week’s mid-term elections. 

It is not easy for Gov. Medalla to resist the President and his predecessor when they make pronouncements which only he is constitutionally entitled to do. Medalla was appointed by the President likely upon the recommendation of Diokno so he is indebted to them for his position and the PHP 42 million remuneration that comes with it. His term expires next year which adds to the pressure on the BSP Governor to play ball with the Administration.

Yet now more than ever is when the BSP must exercise its independence.

The Philippines has a debt of over PHP 13 trillion of which some 30% is in foreign currency and 70% in pesos. Our inflation is now 7.7%, a near 14 year high.. Our trade deficit of $47 billion has grown by 63% from a year ago with further prospect of deterioration as prices of critical commodities like oil and food remain elevated from geo-political conflict and climate change; and interest rates climbing. Our international reserves have dropped from $103 billion early this year to $93 billion. As our economy grows our demand for imports of machinery and raw materials will rise widening our trade gap and pressuring the peso. In this scenario of tighter world financial conditions, continuing inflation and higher trade and budgetary deficits the question becomes how do we finance ourselves?

With our credit rating the Philippines can still access the international debt market but this is going to be more expensive and harder to do. Foreign investors are increasingly wary of emerging market( EM) debt. A number of EM countries are now in serious risk of default which contagion will spread even to better quality borrowers like us. Interest rates worldwide are rising. The Philippines just had to pay 200 basis points more on its last $2 billion international bond offering which is more than 60% of what it paid earlier this year.

In the absence of higher taxes which Sec. Diokno has rejected; the answer to our financing gap must be by borrowing more locally in pesos. This will crowd out private businesses which will slow the economy. To avert this there will be a temptation to increase the money supply to fund growing Government expenditures but this will debase our currency. If uncontrolled this will lead to a spiral of more inflation, a weakening of the peso and yet more inflation. The only guardian of our economy in this scenario of cascading price increases will be the BSP so its independence becomes crucial. Does the BSP Governor have the fortitude to hold his ground?

Medalla has remained relatively silent in the face of the weakness in the peso leaving DoF Sec. Diokno to speak for him. Only when analysts bewailed his absence has he stepped to the podium to push back. He has rejected Sec. Diokno’s strategy of drawing a line in the sand on foreign exchange intervention preferring instead “more flexibility in efficiently managing our foreign exchange reserves”. He also announced a 75 basis point increase in interest rates against Diokno’s suggestion for a 100 bp increase. 

 People who know Gov. Medalla say that despite his mild manner, the man has the backbone to protect the independence of the BSP. He is seemingly less political than his predecessor which gives comfort. However he can often be obfuscating as when he pronounced: “We don’t want to sell so many dollars to defend the peso so the best way to do that  is to let the market know what we want to do”. This may be his way of giving forward guidance but it should be accompanied by real measures such as limiting banks’ overbought dollar positions or suggesting to Congress and DoF Sec. Diokno a tax on windfall FX profits of banks. The Q3 financials of banks are reporting record profits possibly from FX positioning.

We are seeing some steeliness in Medallla to take on, unconsciously, even the President. He recently bewailed the Government’s efforts on the economy:  “The BSP continues to strongly urge the timely implementation of non-monetary government interventions to mitigate the impact of persistent supply side pressures on inflation”. Although perhaps unintentional this spoke to the President’s failure as head of the Dept. of Agriculture to increase food production.

The President reportedly does not take criticism lightly however constructive. We hope Medalla’s forthrightness is taken by BBM in the spirit that it was given. It is time Government officials speak frankly to the truth for only then can we move this country forward.