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High Interest Rates and Robust Growth: A Delicate Balance

Rising interest rates tend to be a precursor of an economic slowdown. A tool to curb surging inflation, higher interest rates in the long run may lead to stable prices, albeit at a cost of sacrificing growth in general. Economic managers, thus, must find the delicate balance between preserving the growth momentum and tempering rising inflation.

 

 

Our economic officials are capably managing rising inflation stemming from high food and oil prices, and now the depreciating peso. What we have is a team of competent and experienced managers who are on top of the situation and who have the means to put it under control, despite the impact of Russia’s invasion of Ukraine, the Covid-19 lockdown in China and the aggressive interest rate hikes in the United States.

 

 

While the challenges seem relentless in the past three years, our economy is actually on track to attain a gross domestic product growth of at least 6 percent this year, with the easing of mobility restrictions.

 

 

Inflation remains a concern, but it is largely due to global price pressures caused by the geopolitical tension in eastern Europe and the US Federal Reserve’s decision to dramatically bump up its interest rate from near zero at the outset of the pandemic to as much as 4 percent this month, which effectively pushed investors to seek the US dollar as a safe haven.

 

 

The inflation rate in October hit 7.7 percent, the highest in 14 years, due to increased food, transport and fuel prices, exacerbated by the peso depreciation against the US dollar. Generally, a weak peso makes prices of imported products like oil more expensive.

 

 

Despite external headwinds such as rising interest rates and higher commodity prices, no less than Fitch Ratings, one of the major international credit rating agencies, affirmed the Philippines’s investment grade score of ‘BBB’ last week, while predicting that the economy would grow 6.8 percent this year.

 

 

Fitch also acknowledged the credibility of the BSP’s inflation-targeting framework, after the central bank adjusted its policy rate by 225 basis points this year to 4.25 percent. Such policy adjustment, however, has not curbed economic activities so far. Per official BSP data, bank lending grew 13.4 percent year-on-year in September, the fastest pace in 27 months.

 

 

The BSP was also an active participant in the foreign exchange market to ensure that the peso would not slip further against the greenback. The peso has been trading at 58 to 59 per dollar in recent weeks, and it seems the central bank will not allow it to breach the 60-to-a-dollar mark to show it is on top of the volatility.

 

 

BSP Governor Felipe M. Medalla himself underscored the need to smoothen FX movements and reduce the instability as he reiterated the bank’s unwavering commitment to use the tools at its disposal to stabilize the exchange rate. “This underscores the importance of a credible central bank,” he was quoted as saying last week.

 

 

The statement is a clear signal to the market that the BSP, which had more than $93 billion in gross international reserves as of September 2022, will do its mandate to achieve financial and price stability. The BSP could tap other financial resources such as remittances from overseas Filipino workers, business process outsourcing receipts and foreign direct investments to guide the foreign exchange rate.

 

 

Another tool at its disposal is the interest rate adjustment that it could decide during the next Monetary Board meeting this month. To communicate the BSP’s intention, Governor Medalla said the bank would most likely increase the overnight borrowing rate by another 75 basis points on November 17 to match the same adjustment announced by the US Fed on November 3. This would bring the benchmark policy rate in the Philippines to 5 percent.

 

 

Increased interest rates have the effect of discouraging people from borrowing and encouraging them to place their money in the bank in the hopes of accruing a bigger interest. So far, this is not happening based on the 13.4-percent bank loan growth in September. Consumer spending and business expansion continue to drive the general economy.

 

 

The BSP seems intent on maintaining the 100-basis-point differential between local and US interest rates, because a narrower gap could encourage investors to dump the peso in favor of the dollar and exacerbate the problem.

 

 

It is a delicate path that the BSP has been treading carefully. An excessive interest adjustment could spook businesses and derail economic recovery.

 

 

I believe the BSP and the economic managers of President Ferdinand Marcos Jr. will masterly guide the Philippine economy toward the transition to a high-interest rate regime spawned by the Fed’s monetary tightening cycle. 

 

 

The Philippine economy is well positioned to thrive in this period because of its rapidly growing middle-income population that will keep the demand for housing, goods and services robust for a very long time.

 

 

Source:

Business Mirror/Author/MannyVillar