Challenges Facing the BSP in Challenges Facing the BSP in Conducting Monetary Conducting Monetary

Operations under Excess Operations under Excess LiquidityLiquidityDiwa C. Guinigundo

Deputy GovernorMonetary Stability Sector

Bangko Sentral ng Pilipinas

I. Excess liquidity and foreign exchange inflows

II. Challenges to monetary policyIII. Policy responses IV. Future policy directions

Outline of Presentation Outline of Presentation

I. Excess Liquidity and Foreign Exchange Inflows

Domestic Liquidity (Annual growth rate in percent)

Domestic liquidity growth strong, interest rates Domestic liquidity growth strong, interest rates decliningdeclining

2

3

4

5

6

7

8

9

J M M J S N J M M J S N J M M J S N J M M J0

5

10

15

20

25

30

‘04 ‘05 ‘06 ‘07

LIQUIDITY GROWTH LIQUIDITY GROWTH (RHS)(RHS)

91 DAY TBILL (LHS)91 DAY TBILL (LHS)

Loans Outstanding: Other Depository Corporations (ODCs) (Annual

growth rate in percent)

Credit growth is moderateCredit growth is moderate

2004 2005 2006 2007-4

-2

0

2

4

6

8

J M M J S N J M M J S N J M M J S N J M M J

Domestic liquidity growth driven by Domestic liquidity growth driven by growth in NFAgrowth in NFA

Growth Rates (in%) Dec 2004

Dec 2005

Dec 2006

August 2007

M3 10.3 10.3 22.7 14.9

Net foreign assets 13.4 34.5 49.9 39.7

Net domestic assets 8.8 (0.3) 6.3 (4.6)

BoP(US$Mil) -280 2410 3769 6659*

*Jan-Sept 2007

Are the flows witnessed in recent years sustainable?Are the flows reversible?Are they volatile?

Some issues on foreign exchange flows:

The critical objective is to encourage more stable long-term flows in order to maximize the benefits of additional foreign capital

Current account surpluses rather than capital inflows are the main source of FX inflows

Source: BIS background note for a BIS Working Party Meeting on Monetary Policy in Asia on 7 and 8 June 2007 in Bangkok

Emerging Asia: Balance of Payments and Reserve Accumulation (in percent of GDP)

Source: IMF Regional Economic Outlook: Asia and the Pacific, April 2007

Philippines: Balance of Payments and Reserve Accumulation (in percent of GDP)

Balance of Payments and Reserve Accumulation

in percent of GDP (1999-1st Semester 2007)

-4

-2

0

2

4

6

1999 2000 2001 2002 2003 2004 2005 2006 Jan-Jun2007

051015202530354045

Current Account Balance (LHS)

Capital Account Balance (LHS)

Gross International Reserves (RHS)

For the Philippines, net increases in the current account balance is largely due to

remittances

2006 Jan-Jun 2007

Increase in Trade Balance: $0.8 bn Increase in Trade Balance: $0.4 bn

Increase in Services Balance: $0.7 bn Decrease in Services Balance: $0.2 bn

Increase in Balance on Income and Transfers (including remittances): $1.5 bn

Increase in Balance on Income and Transfers (including remittances): $0.9 bn

Increase in Current Account Balance in 2006: $3.0 bn

Increase in Current Account Balance in Jan-Jun 2007: $1.1 bn

Philippines: Components of $3.0 bn and $1.1 bn Increase in the Current Account in 2006 and Jan-Jun of 2007($ bn)

Philippines: Main sources of FX inflows appear to be relatively stable

Relative Magnitude and Volatility of Selected FX Inflows (2000 – 2006)

Sources of FX Inflows % of GDP C.V.2/

Overseas Filipinos Remittances1/ 9.7 11.9

Exports of Goods and Services 48.0 6.3

Foreign Direct Investments Inflows 1.5 63.9

Foreign Portfolio Investment Inflows 1.7 97 Note: 1/ Coursed thru the banking system (Table 11 of SPEI)2/ Coefficient of Variation = (Standard Deviation / Mean ) x 100%

Less vulnerable to shocks and “sudden stops”Persistent currency appreciation pressures, resulting in large reserve accumulation

Implications of higher current account balances than net capital inflows:

Strong liquidity and credit growth

Downside risks:

II. Challenges in the Conduct of Monetary Policy

Conduct of monetary policy is more challenging

Capital inflows have increased pressures on currencies to appreciate

Surging capital inflows have enhanced liquidity growth, inflation pressures

Policy complications posed by capital inflows

Higher interest rates could address liquidity concerns but could induce more capital inflows

Lower interest rates may be consistent with a benign inflation outlook but could spur domestic liquidity growth

III. Policy Response

Market-determined exchange rate policy Building up reserves to temper foreign

exchange market volatility Foreign exchange liberalization measures Prepaying a substantial amount of debt Fine-tuning of monetary operations

The BSP’s Policy Mix

Peso per US Dollar Rate

44

46

48

50

52

54

56

58

J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S

2004 2005 2006 2007

Monthly Averages End-of-Period

Exchange rate policy has been flexibleExchange rate policy has been flexible

End-Sep ‘0745.063

Aug ‘0746.965

GIR has been increasingGIR has been increasing

15,000

20,000

25,000

30,000

35,000

J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S

2004 2005 2006 2007

Gross International Reserves of BSP end-of-period (in million US dollars) End-Sep ‘07

$30.9 billion

Gross International Reserves of BSP

Increase in OTC purchases by residents without documentation

Increase in allowable outward investments by residents without BSP approval and registration

Imposed symmetric limit of 20% of unimpaired capital with an absolute limit of US$50 million on overbought and oversold positions of banks

Foreign exchange liberalization : 1st wave

Total Prepayments (J anuary-J une 2007) 2,625.50

Loans Owed to Residents 1,687.30Public 1,078.50

Private 608.80

Loans Owed to Non-Residents 938.20Public 329.40

Private 608.80

Medium and Long-Term Foreign/ Foreign Currency Denominated Loans

Total Prepayments (in million US dollars)

Prepayment of Debt

Allowing trust entities to deposit funds with the BSP special deposit account facilityEncouraging public and private pension funds and other government-owned and –controlled corporations to deposit funds with the BSPAllowing special deposit account placements as alternative compliance with the liquidity floor requirements for government deposits

Fine-tuning of monetary policy instruments

Special Deposit Account (SDA) (in million pesos)

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

500,000

J F M A M J J A S O N D J F M A M J J A S Asof 22Oct

2006 2007

SDA Levels

May ‘07222, 892

As of 22 Oct ’07

471, 943

RRPs

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

J F M AM J J A S O N D J F M AM J J A S O N D J F M AM J J A S O N D J F M AM J J A S O

2004 2005 2006 2007 asof22

Oct

RRP Levels

22 Oct‘07199,895

Reverse Repurchase (RRP) (in million pesos)

(Apr’07)341, 137

(May’07)240, 074

Domestic Liquidity (Annual growth rate in percent)

0

5

10

15

20

25

30

J F MA M J J A S O N D J F M A M J J A S O N D J F MA M J J A S O N D J F MA M J J A

2004 2005 2006 2007

0

1

2

3

4

5

6

7

8

9

10

INFLATION (right scale)

LIQUIDITY (left scale)

(Aug’05)17.0

(Dec’06)22.7

(Apr’07)26.1

(Feb-Mar’06)7.6

Aug ’0714.9

Aug ’072.4

IV. Future Policy DirectionIV. Future Policy Direction

Facilitate productive use of inflowsEncourage private sector capital outflowsInsure against sudden reversals in flowsImprove BSP's ability to offset the effects of inflows

Long-term approaches:

Encourage investments by Overseas Filipinos

Facilitate productive use of inflows

Overseas Filipinos (OFs) include:

= Permanent Migrants + Overseas Filipino Workers

(= temporary + irregular)

Note: In 2006, the stock of OFs is estimated to be around 8.2 million (10% of the total population), of which 4.7 million are OFWs.

On encouraging investments by OFs(First wave: facilitating remittance flows)

Promoted transparency and competition by issuing Circular no. 534 (remittance charges disclosure).Improving payment and settlement systems by approving setting up of local bank’s remittance centers & branches abroad, authorized rural banks to accept FCDs, approved interconnection of three (3) ATM networks, and approved use of new technologies as mode of remittance (e.g. internet and SMS)Promoted financial literacy campaigns among OFs/families

What the BSP has done:

Foreign exchange liberalization Facilitate overseas portfolio investments by domestic investors

Encourage private sector capital outflows

On encouraging private sector capital outflows through further FX liberalization:

Phase 1: BSP Circular 561 (symmetrical limit of 20% of unimpaired capital [OS/OB positions] + increased outward investment by Philippine residents to $12B/year); BSP Circular 565 (allowed thrift banks to invest in FCD debt instruments)

Phase 2: Simplifying documentary requirements for trade and non-trade; promoting cross-border transport of the peso; and facilitating derivative trading

What the BSP has done:

Pursue BSP’s remaining P40B capitalizationPursue amendments to BSP Charter, to allow BSP to issue its own instruments

Improve BSP's ability to offset the effects of inflows

Sound macroeconomic policyProvide high-quality, timely information to market participantsRisk management through financial reform, strengthened supervision and regulationPursue multilateral/regional insurance arrangements against sudden stops

Ensure against reversals in portfolio flows

On insuring against reversals in portfolio flows

Pursuing multilateral/regional insurance arrangements against sudden stops

Philippine involvement in ASEAN+3 Regional Financial Cooperation (e.g. Chiang Mai initiative, Bilateral swap agreements, Asian Bond Markets Initiative, Economic Reviews and Policy Dialogue)

Adopting risk management through financial reform, strengthened supervision and regulation

MB Resolution No. 1516 (approved the BSP’s implementation plans for Basel II)

What the BSP has done:

Thank you.Thank you.