Monetary policy ‘too loose’ after cut in bank reserves

A CUT in bank reserves introduced by the central bank last week needs to be followed by higher interest rates, an analyst said, as keeping an “ultra-loose” monetary policy would leave the peso too weak and the economy closer to overheating.

Peter Lundgreen, founding chief executive officer at Lundgreen’s Capital, said the decision of the Bangko Sentral ng Pilipinas ( BSP) to cut reserve levels bolsters the case for a rate hike as soon as possible.

“The risk is that the central bank is running a too loose monetary policy — it’s the biggest threat to the economy,” Mr. Lundgreen said in an interview in Makati City yesterday.

“As bullish as I have been (towards the economy), there is an extreme risk for overheating and I view that the central bank is way behind the curve in hiking rates.”

The BSP on Thursday announced a one percentage point cut in the 20% reserve requirement ratio ( RRR) imposed on universal and commercial banks, even as monetary authorities described the move as just an “operational” adjustment in support of a government agenda to deepen the local debt market.

The change allows the central bank to focus on “auction-based” instruments in influencing market rates rather than relying on bank reserve levels, as banks have abundant money supply.

By March 2, big banks need to hold on to 19% of total deposits as reserves from 20% previously.

The RRR cut is estimated to unlock about P90 billion of idle funds, which the central bank expects to shore up through its weekly term deposit auctions and via placements in its overnight deposit facility.

BSP Managing Director Francisco G. Dakila, Jr. noted that the central bank can now rely better on the weekly term deposit auctions to influence market rates and can deploy other macroprudential and risk management measures to contain the bank reserve requirement cut’s potential impact on inflation and credit growth.

“This has been communicated already and the central bank made fine work in the guidance of the market on this… But it is actually making monetary policy even loose. It calls for even more rate hikes as a counter measure,” Mr. Lundgreen said of the RRR.

Domestic liquidity expanded by 11.9% in December to P10.6 trillion while bank lending surged by 19%, according to latest available central bank data.

Mr. Lundgreen said the BSP is behind the curve by at least two rate increases, which he believes should have been introduced in 2017.

The monetary authority last hiked benchmark borrowing rates in September 2014. In June 2016, it introduced operational cuts to policy rates in making the shift towards an interest rate corridor, leaving rates within the 2.5-3.5% range.

Mr. Lundgreen likewise warned that the additional liquidity raises concern as to whether this will be used productively.

“It frees up lending capacity among banks. It is extremely critical if this lending capacity ends up financing government infrastructure investments,” the Denmark-based investment advisor said.

Loose monetary policy would likewise drive the further depreciation of the peso, which yesterday plunged to P52.34 versus the dollar, its weakest in nearly 12 years.

‘CONFUSING THE MARKET’

In a separate report, Credit Suisse analyst Michael Wan pointed out that the BSP’s reserve cut “risks confusing the market,” as it came at a time of robust credit growth, a wider current account deficit and a spike in commodity prices.

“Ultimately, we think real interest rates could be too low for an economy growing at 9-10% in nominal terms,” Mr. Wan said in a commentary released yesterday.

“With the BSP remaining dovish in its statements so far with no decisive shift to raising rates yet, we see space for the currency to continue underperforming the region.”

Central bank officials have said that they will remain data-dependent in their policy moves, but assured that they stand ready to tweak rates to respond to emerging risks particularly as inflation is expected to remain elevated in the coming months.