MANILA, Philippines - The International Monetary Fund (IMF) has reinforced recent statements from the Bangko Sentral ng Pilipinas (BSP) on the need to use other tools beside policy rates in addressing threats from large capital inflows.
As continued inflows to the Philippines could potentially stoke inflation and contribute to more peso appreciation, the IMF, in a report titled “The Effectiveness of Monetary Policy Transmission Under Capital Inflows: Evidence from Asia” said there could be limitations on how monetary policy could respond.
“There could be constraints in the implementation of monetary policy when faced with large capital inflows; for example, tightening monetary policy could reinforce more inflows,” said the paper authored by Sonali Jain-Chandra and D. Filiz Unsal.
“Therefore, in the face of a surge in capital inflows, policymakers should remain ready to use other policy instruments such as macroprudential policies as a complement to appropriate macroeconomic policy settings,” it explained.
After cutting policy rates anew by 25 basis points last Oct. 25, the BSP has admitted there is a need to use other mechanisms to address the surge of capital inflows, which if not managed well, could harm the economy.
“We remain open to a balanced use of instruments to address the challenging nature of surging capital flows. We will look at more targeted, but also on the more effective and more potent instruments depending on the needs of economy,” BSP Assistant Governor Ma. Cyd Tuaño-Amador said.
Those instruments, BSP Deputy Governor Diwa Guinigundo said earlier, included previous BSP actions such as banning foreign funds in special deposit accounts, tightening reporting systems for real estate loans and increasing capital charges of non-deliverable forwards.
Jain Chandra and Unsal said local and external factors drive capital inflows to emerging markets such as the Philippines. “As expected, the contributions of foreign interest rates and global risk aversion increase with maturity, consistent with the observation that foreign investors have been more active at the longer end of the yield curve,” they said, adding that “at the short-end of the yield curve, domestic factors play a more prominent role.”
With near-zero interest rates in developed markets in the US and Europe, investors seeking higher returns have flocked to Asia where rates are higher, Philippine key rates, for instance, are at 3.5 percent and 5.5 percent.
This has caused peso to strengthen by more than six percent this year. A strong peso makes export products more expensive, possibly denting demand. It also trims the value of remittances from overseas Filipinos.
“We find that the policy interest rate remains a powerful tool in macroeconomic stabilization in Asia. Going forward, however, continued integration of regions’ capital markets with the world economy could make external developments the dominant factor in determining domestic rates,” the paper explained.