As inflation in the Philippines continues to decelerate, which is giving the Bangko Sentral ng Pilipinas (BSP) room to consider cutting the key policy rate, lead economist Jun Neri warns of the potential downside to an aggressive rate reduction.
In an online briefing, Neri said economic gains might not be sustainable if there would be drastic cuts to the country’s interest rate.
The BSP on Wednesday, June 21, kept the interest rate unchanged at 6.25 percent for the second straight meeting as inflation eased for the fourth straight month in May to 6.1 percent.
Inflation could settle within the target band of two to four percent late this year, but the average inflation for the year is still expected to remain above the target at 5.4 percent.
BSP Governor Felipe Medalla said he wanted to see inflation fall to three percent for at least two consecutive months before even considering a rate cut.
Cutting rates could boost economic activities and the market, but Neri argued it might not be sustainable if the cuts were abrupt.
“If we lower our policy rate aggressively in the next 12 to 18 months to the point where, say we end up at a 6.5 percent policy rate, if we bring it down to three percent or maybe 2.5 percent, we could subject the market to this trauma,” Neri said, referring to the currency trauma in previous years where depreciation of the peso wiped out the gains of foreign fund managers.
Neri added that inflation should not be the only consideration in policy rate adjustments but also the interest rate differential. The United States Federal Reserve paused hiking interest rates in June.
“BSP might have an opening very soon, sooner than the US, to cut rates. Pero they have to be mindful of the differential between our rates and the US. Kung hindi pa mag-cut ang US and even if the Philippines has an opening, the chance to reduce policy rates, they may be forced either to do it gradually or not at all lalo na kung nag-hike pa sa US,” Neri said.
Neri said challenges for the Philippines include its high current account deficit while the foreign reserves are falling below external debt. The gross international reserves level is at $101 billion while external debt is now $119 billion as of the first quarter of the year.
Inflation was estimated to drop below four percent by October at the earliest or by the end of the year, but it could also go the other way.
“[The] policy rate is now higher than the inflation rate and given these recent trends, maraming pwede maging problema, like LRT [light rail transit] will be increasing rates, ASF [African swine fever] is still a problem, our restaurant industry is still having problems with the cost of raw materials. We could see a rebound in inflation,” he said.
To support sustainable growth in the medium term, the Philippines should gradually cut interest rates if it decides to do so at the right time and rebuild its international reserve buffer. (ABS-CBN News)