BSP seeks to allay inflation worries from RRR reduction

ADDITIONAL money supply due to cuts in bank reserves has been siphoned by the central bank’s open market operations, its chief said, as he sought to dispel worries that these adjustments offset rate tightening moves.

The Bangko Sentral ng Pilipinas (BSP) has trimmed the reserve requirement ratio (RRR) to 18% via two equal one-point reductions that took effect in March and June. These moves are estimated to have released around P200 billion in additional liquidity into the financial system, before policy interest rate hikes announced by monetary authorities in their May and June policy reviews.

The Monetary Board raised rates by 25 basis points in each of those meetings, citing the need for policy tightening to rein in inflation pressures as prices of basic goods and services have kept rising faster over the past six months.

A number of economists and market watchers have said that the BSP’s recent moves have been a source of confusion as they appear contradictory.

“It is easy to say that the RR (ratio) cuts result in injecting liquidity into the system at a time when inflation seems to be on the rise… This is a simplistic view,” BSP Governor Nestor A. Espenilla, Jr. said in a speech before the Bankers Institute of the Philippines on Friday last week.

“Monetary policy is evolving in the context of a financial system that is becoming more and more sophisticated. Thus, all our present reform actions — reducing our reliance on the reserve requirement to control money supply, our liberalization of the FX market, our efforts to deepen the capital market… All our macro- and micro- prudential measures are not diversions from the goals of price and financial stability.”

Mr. Espenilla added that the BSP has siphoned liquidity released by the RRR cuts. “In fact, the liquidity releasing impact of the two previous RR (ratio) cuts that we’ve done so far this year is actually less than the liquidity draining impact of open market operations and our significant FX (foreign exchange) operations to manage excessive peso volatility in the face of external uncertainties,” he said. “This has resulted in tighter financial conditions as evidenced by rising market interest rates.”

The BSP has raised auction volumes for its weekly term deposit auctions, where average yields have also moved higher to hover close to the four-percent ceiling. Mr. Espenilla also pointed out that the RRR cuts are not changes to the policy stance, and were introduced to “promote efficient financial intermediation” and help curb shadow banking, as it arms big banks with usable cash to keep up with buoyant economic activity.

Mr. Espenilla added the RRR level should reach single digit — coming from 20% — “five years from now” or by the time he ends his term as BSP chief.