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Challenges Facing the BSP in Conducting Monetary Operations under Excess Liquidity Diwa C. Guinigundo Deputy Governor Monetary Stability Sector Bangko Sentral ng Pilipinas Outline of Presentation Excess liquidity and foreign exchange inflows II. Challenges to monetary policy III. Policy responses IV. Future policy directions I. I. Excess Liquidity and Foreign Exchange Inflows Domestic liquidity growth strong, interest rates declining 9 Domestic Liquidity (Annual growth rate in percent) 30 LIQUIDITY GROWTH (RHS) 8 7 91 DAY TBILL (LHS) 25 20 6 15 5 10 4 3 5 2 0 J M M J S N J M M J S N J M M J S N J M M J ‘05 ‘06 ‘04 ‘07 Credit growth is moderate Loans Outstanding: Other Depository Corporations (ODCs) (Annual growth rate in percent) 8 6 4 2 0 J M M J S N J M M J S N J M M J S N J M M J -2 -4 2004 2005 2006 2007 Domestic liquidity growth driven by growth in NFA Growth Rates (in%) Dec 2004 Dec 2005 Dec 2006 August 2007 M3 10.3 10.3 22.7 14.9 Net foreign assets 13.4 34.5 49.9 39.7 Net domestic assets 8.8 (0.3) 6.3 (4.6) -280 2410 3769 6659* BoP(US$Mil) *Jan-Sept 2007 Some issues on foreign exchange flows: Are the flows witnessed in recent years sustainable? Are the flows reversible? Are they volatile? The critical objective is to encourage more stable long-term flows in order to maximize the benefits of additional foreign capital Current account surpluses rather than capital inflows are the main source of FX inflows Source: BIS background note for a BIS Working Party Meeting on Monetary Policy in Asia on 7 and 8 June 2007 in Bangkok Emerging Asia: Balance of Payments and Reserve Accumulation (in percent of GDP) Source: IMF Regional Economic Outlook: Asia and the Pacific, April 2007 Philippines: Balance of Payments and Reserve Accumulation (in percent of GDP) 6 Balance of Payments and Reserve Accumulation in percent of GDP (1999-1st Semester 2007) Current Account Balance (LHS) Capital Account Balance (LHS) 4 Gross International Reserves (RHS) 2 0 -2 -4 1999 2000 2001 2002 2003 2004 2005 2006 Jan-Jun 2007 45 40 35 30 25 20 15 10 5 0 For the Philippines, net increases in the current account balance is largely due to remittances Philippines: Components of $3.0 bn and $1.1 bn Increase in the Current Account in 2006 and Jan-Jun of 2007($ bn) 2006 Jan-Jun 2007 Increase in Trade Balance: $0.8 bn Increase in Trade Balance: $0.4 bn Increase in Services Balance: $0.7 bn Decrease in Services Balance: $0.2 bn Increase in Balance on Income and Transfers (including remittances): $1.5 bn Increase in Balance on Income and Transfers (including remittances): $0.9 bn Increase in Current Account Balance in 2006: $3.0 bn Increase in Current Account Balance in Jan-Jun 2007: $1.1 bn Philippines: Main sources of FX inflows appear to be relatively stable Relative Magnitude and Volatility of Selected FX Inflows (2000 – 2006) Sources of FX Inflows % of GDP C.V.2/ Overseas Filipinos Remittances1/ 9.7 11.9 Exports of Goods and Services 48.0 6.3 Foreign Direct Investments Inflows 1.5 63.9 Foreign Portfolio Investment Inflows 1.7 97 Note: 1/ Coursed thru the banking system (Table 11 of SPEI) 2/ Coefficient of Variation = (Standard Deviation / Mean ) x 100% Implications of higher current account balances than net capital inflows: Less vulnerable to shocks and “sudden stops” Persistent currency appreciation pressures, resulting in large reserve accumulation Downside risks: Strong liquidity and credit growth II. Challenges in the Conduct of Monetary Policy Conduct of monetary policy is more challenging Capital inflows have increased pressures on currencies to appreciate Surging capital inflows have enhanced liquidity growth, inflation pressures Policy complications posed by capital inflows Higher interest rates could address liquidity concerns but could induce more capital inflows Lower interest rates may be consistent with a benign inflation outlook but could spur domestic liquidity growth III. Policy Response The BSP’s Policy Mix Market-determined exchange rate policy Building up reserves to temper foreign exchange market volatility Foreign exchange liberalization measures Prepaying a substantial amount of debt Fine-tuning of monetary operations Exchange rate policy has been flexible 58 Peso per US Dollar Rate 56 54 52 50 Aug ‘07 46.965 48 End-Sep ‘07 46 45.063 44 J F MAM J J A S O N D J F MAM J J A S O N D J F MAM J J A S ON D J F MAM J J A S 2004 2005 Monthly Averages 2006 End-of-Period 2007 GIR has been increasing 35,000 Gross International Reserves of BSP end-of-period (in million US dollars) End-Sep ‘07 $30.9 billion 30,000 25,000 Gross International Reserves of BSP 20,000 15,000 J F MAM J J A S O N D J F MAM J J A S O N D J F MAM J J A S O N D J F MAM J J A S 2004 2005 2006 2007 Foreign exchange liberalization : 1st wave Increase in OTC purchases by residents without documentation Increase in allowable outward investments by residents without BSP approval and registration Imposed symmetric limit of 20% of unimpaired capital with an absolute limit of US$50 million on overbought and oversold positions of banks Prepayment of Debt Total Prepayments (in million US dollars) Total Prepayments (January-June 2007) 2,625.50 Loans Owed to Residents 1,687.30 Public Private Loans Owed to Non-Residents Public Private 1,078.50 608.80 938.20 329.40 608.80 Medium and Long-Term Foreign/Foreign Currency Denominated Loans Fine-tuning of monetary policy instruments Allowing trust entities to deposit funds with the BSP special deposit account facility Encouraging public and private pension funds and other government-owned and – controlled corporations to deposit funds with the BSP Allowing special deposit account placements as alternative compliance with the liquidity floor requirements for government deposits 500,000 Special Deposit Account (SDA) (in million pesos) As of 22 Oct ’07 471, 943 450,000 400,000 350,000 May ‘07 300,000 222, 892 250,000 SDA Levels 200,000 150,000 100,000 50,000 0 J F M A M J J 2006 A S O N D J F M A M J 2007 J A S As of 22 Oct Reverse Repurchase (RRP) RRPs (in million pesos) 400,000 (Apr’07) 341, 137 350,000 300,000 (May’07) 240, 074 250,000 22 Oct‘07 199,895 RRP Levels 200,000 150,000 100,000 50,000 0 J F M AM J J A S O N D J F M AM J J A S O N D J F M AM J J A S O N D J F M AM J J A S O 2004 2005 2006 2007 as of 22 Oct 30 Domestic Liquidity (Annual growth rate in percent) (Feb-Mar’06) 7.6 25 20 (Apr’07) 26.1 (Dec’06) 22.7 INFLATION (right scale) (Aug’05) 17.0 15 Aug ’07 14.9 10 LIQUIDITY (left scale) 5 0 Aug ’07 2.4 J F MAM J J A SOND J FMAM J J A SOND J F MAM J J A SOND J FMAM J J A 2004 2005 2006 2007 10 9 8 7 6 5 4 3 2 1 0 IV. Future Policy Direction Long-term approaches: Facilitate productive use of inflows Encourage private sector capital outflows Insure against sudden reversals in flows Improve BSP's ability to offset the effects of inflows Facilitate productive use of inflows Encourage investments by Overseas Filipinos Overseas Filipinos (OFs) include: = Permanent Migrants + Overseas Filipino Workers (= temporary + irregular) Note: In 2006, the stock of OFs is estimated to be around 8.2 million (10% of the total population), of which 4.7 million are OFWs. What the BSP has done: On encouraging investments by OFs (First wave: facilitating remittance flows) Promoted transparency and competition by issuing Circular no. 534 (remittance charges disclosure). Improving payment and settlement systems by approving setting up of local bank’s remittance centers & branches abroad, authorized rural banks to accept FCDs, approved interconnection of three (3) ATM networks, and approved use of new technologies as mode of remittance (e.g. internet and SMS) Promoted financial literacy campaigns among OFs/families Encourage private sector capital outflows Foreign exchange liberalization Facilitate overseas portfolio investments by domestic investors What the BSP has done: On encouraging private sector capital outflows through further FX liberalization: Phase 1: BSP Circular 561 (symmetrical limit of 20% of unimpaired capital [OS/OB positions] + increased outward investment by Philippine residents to $12B/year); BSP Circular 565 (allowed thrift banks to invest in FCD debt instruments) Phase 2: Simplifying documentary requirements for trade and non-trade; promoting cross-border transport of the peso; and facilitating derivative trading Improve BSP's ability to offset the effects of inflows Pursue BSP’s remaining P40B capitalization Pursue amendments to BSP Charter, to allow BSP to issue its own instruments Ensure against reversals in portfolio flows Sound macroeconomic policy Provide high-quality, timely information to market participants Risk management through financial reform, strengthened supervision and regulation Pursue multilateral/regional insurance arrangements against sudden stops What the BSP has done: On insuring against reversals in portfolio flows Pursuing multilateral/regional insurance arrangements against sudden stops Philippine involvement in ASEAN+3 Regional Financial Cooperation (e.g. Chiang Mai initiative, Bilateral swap agreements, Asian Bond Markets Initiative, Economic Reviews and Policy Dialogue) Adopting risk management through financial reform, strengthened supervision and regulation MB Resolution No. 1516 (approved the BSP’s implementation plans for Basel II) Thank you.