HSBC sees inflation peaking near 4% by midyear before receding

INFLATION will likely peak in June at close to 4%, a level that could prod the Bangko Sentral ng Pilipinas (BSP) to raise rates sometime during the second quarter to keep prices at bay, analysts at a global bank said.

The Hong Kong and Shanghai Banking Corp. ( HSBC) said the full impact of the tax reform package implemented on Jan. 1 will be felt during the first half, which will drive inflation upward in the coming months.

“Headline inflation will also come close to the 4% upper bound of [ the target band] in June, before descending below 3% by end- 2018. This is partly driven by second round impacts of tax reform — which will add a total of 0.4-0.7 ppt (percentage points) to headline inflation as per BSP forecasts,” bank economists said in a Jan. 8 report, noting that they are “slightly concerned” about the pace of price increases.

The tax reform law, signed as Republic Act 10963, reduces personal income taxes for those earning below P2 million, alongside a simpler system for computing donor and estate taxes. Foregone revenue will be offset by the removal of some exemptions to value-added tax as well as higher duties for fuel, cars, tobacco, coal and sugar-sweetened drinks, among others.

The central bank has acknowledged that inflation will rise this year due to tax reform, although BSP Deputy Governor Diwa C. Guinigundo said the higher duties will add less than one ppt to inflation this year.

Higher duties to be imposed under the tax reform package will likewise have a “transitory” impact on consumer prices, BSP Governor Nestor A. Espenilla, Jr. said, as he assured that the central bank is ready to step in “to ward off any threat” to the 2-4% inflation target.

Inflation is expected to average 3.4% in 2018, slightly higher than last year’s 3.2%.

Despite these comments, HSBC said it still expects several policy responses from the central bank to keep up with rising inflation, with current benchmark rates capped at 3.5%.

“The BSP has made clear its preference not to adjust monetary policy in the absence of pressing inflation risks. However, we forecast one 25bp hike in 2Q18 to defend the upper bound of the inflation target,” the report read.

The policy tightening will be accompanied by a reduction of the reserve requirement ratio (RRR) imposed on banks within the first semester. A cut worth 100 basis points is expected to “keep liquidity flush, and fulfil policy goals to deepen financial markets,” the bank said.

Mr. Espenilla has said that he personally wants to see the RRR reduced to single-digit levels, but such a change will be gradual and will be considered given emerging liquidity conditions. Big banks have said that they also favor an RRR cut as it would unlock more funds and boost their lending activity, which in turn will support robust economic growth.

HSBC expects the Philippine economy to expand 6.7% this year, matching the pace expected for 2017 although below the government’s 7-8% growth goal.

Bank economists expect investment and consumption to drive growth further, particularly with an infrastructure spending boost from the government’s “Build, Build, Build” initiative.

Meanwhile, consumer spending in the Philippines will likely recover in 2018 despite slower growth last year, amid greater scope for increased retail lending at a time of bigger disposable incomes.

“In the Philippines we expect a recovery in private consumption in 2018, partly fuelled by a likely acceleration in remittances in 4Q ( more than seasonality usually suggests),” HSBC said.

If realized, this would reverse the slower growth in household spending between July and September at 4.5% from the previous year, compared with an 8.3% climb in government spending. Bank economists attribute the slowdown to a “temporary” pullback in remittances and a transitional pickup in the number of jobless Filipino men.

Consumption is expected to grow faster during the year ahead.

“[T]he outlook for domestic job creation is strong: construction sector employment is likely to increase, tourism flows are recovering, and the BPO sector seems to have resumed a fast pace of hiring after a lull in 2016,” the report read.

“Over the medium term, thanks to having Asia’s lowest stock of household debt, there is significant room for expansion in the mortgage and consumer loan markets.”

BSP Deputy Governor Chuchi G. Fonacier said the retail segment will be the battleground for banks this year, with a stronger middle-class segment and as the corporate sector grows saturated.

HSBC, however, noted that the domestic economy has been “slightly less dependent” on private consumption given a sustained increased in infrastructure investment. Still, private spending accounts for roughly 70% of gross domestic product.