Medalla’s call and hearing ears

PHILIPPINE central bank chief Felipe Medalla attends an economic briefing following President Ferdinand Marcos, Jr.’s first State of the Nation Address on July 26. — REUTERS

One day after the Philippine Statistics Authority announced the 14-year high October 2022 inflation rate of 7.7%, both the broadcast and print media reported the “frustration” of Bangko Sentral ng Pilipinas (BSP) Governor Philip Medalla “over the Department of Agriculture (DA) led by President Bongbong Marcos in his free time.”

In fairness to the BSP, its press statement blamed neither the President nor the DA over the worsening price developments. It was rather a broad sweep of non-monetary government interventions that needed to be summoned to deal with the highly destabilizing consequences of spiraling inflation.

The media reports must have read rather liberally between the lines of the BSP’s press release on the medium-term inflation path, although with some reason: “The BSP continues to strongly urge the timely implementation of non-monetary government interventions to mitigate the impact of persistent supply side pressures on inflation.” This formulation contrasts with its specific comment on the October inflation which “reiterated its support for the national government’s efforts to improve farm productivity and address supply bottlenecks.”

Quite ironic, but it is the monetary authorities in charge of demand management who have to remind government that the country’s supply conditions are abetting, rather than mitigating, inflation. There is no other option but for the BSP to champion this cause because tight food supply and high fuel prices are known to trigger second-round effects and initiate a price-wage spiral.

For the benefit of our readers, many central banks around the globe run web pages containing some frequently asked questions (FAQs) about the dynamics of inflation. In these pages, they would invariably point to four explanatory variables namely, demand and supply factors, exchange rate movements, and inflation expectations.

Although late by a couple of months, the BSP has decisively tightened monetary policy, prevented the free fall of the peso, and regulated the volume of liquidity and credit in the economy. In short, the demand side is covered by the monetary authorities, complete with clear forward guidance, in fact too clear for their own good. For instance, the BSP announced that its policy rate would be adjusted by another 75 basis points two weeks before its actual meeting on Nov. 17. That would amount to self-quarantine for two weeks before the actual meeting is held.

In anticipation, the market could therefore undertake steps to preempt what the BSP intends to achieve and, in the process, either neutralize its telegraphed move or worsen it. The increase in market rates ahead of the Nov. 17 meeting is one good example. The BSP’s preference has been revealed, it has chosen to tie its hands.

We would not be too worried about the impact of the sustained contractionary policy of the BSP on the economy. Our economic prospects are not hinged on zero or negative growth but on 6-7.5% which by any standard is robust. In short, the economy can absorb these tightening moves by the BSP. That demand remains strong is also shown by the increase in the core inflation to 5.9% in October from 5% in September.

But the supply side is more problematic. The BSP previously identified itself with the “transitory” camp, that group of economists and policymakers who openly announced that inflation is more transitory, there is nothing permanent about it, and therefore monetary tightening by the BSP is unnecessary. This would explain the BSP’s tardiness in the policy space until energy and food prices forced it to begin tightening. Before we knew it, the second-round effects began ratcheting. And in the last couple of days, talk was rife in the labor market that new petitions might be filed for another round of wage adjustments. Inflation has become more stubborn, and it is decimating the people’s purchasing power.

Medalla’s beef against the supply side is well founded. The recent PSA report documents that the latest inflation rate is further driven by bad supply conditions in the Philippines including poor agricultural production, import restriction, and faulty logistics. For October 2022, food and alcohol prices shot up by 9.4% from only 7.4% in September. By component, more than 5% inflation was obvious for alcohol and tobacco (10.4%), housing, utilities and other fuels (7.4%), and restaurants and accommodation (5.7%). Although slower, inflation for transport remained double digit at 12.5% while food inflation stood at 9.8%, courtesy of more expensive vegetables at 16% as well as meat at 11.5%.

Thanks to the rice tariffication bill, rice is no longer the major food inflation driver, growing only by 2.5% against corn at 27.4%; flour and bakery products at 9.8%; fish and other seafood at 9.4%; milk and other dairy products, 8.7%; and, yes, sugar inflation — even as sugar is purportedly in abundant supply, it surged by 34.4%. Promoting farm productivity and more efficient manufacturing is not something we do overnight to fight inflation. It entails a process and it takes time.

The peso’s sharp depreciation this year has added more worries to our policymakers. The pandemic lockdown infused the peso with artificial strength, averaging P49.624 in 2020 and P49.255 in 2021 to a dollar, only to reflect significant weakening when the economy regained its footing in 2022. For the first 10 months of 2022, the peso averaged P54.0397 to a dollar. In September and October alone, the domestic currency swung between P57 and P59, delivering inflationary punches to the population.

The Palace and some economic managers must have been carried away when they pledged and announced to the market that they were prepared to spend at least $10 billion to defend the peso. The peso is weak because we are spending more dollars than we are earning, both in our external trade in goods and services as well as in financial transactions like investments and loans. Our deficit of nearly $8 billion in the balance of payments is bound to increase as the US Fed sustains its ultra-tight monetary policy. Without the BSP intervention, and the increase in the policy rates since May, the peso could have been more battered. But as long as the fundamental reasons of the peso’s depreciation persist, we might just be tilting at the windmills.

Finally, the last driver of inflation is inflation expectations. It is not enough to recognize that inflation expectations could be self-fulfilling. They do not only capture market sentiment, which is more futuristic, but they also reflect actual price movements on the ground. What is key is to discern what the inflation report is saying and to where the inflation forecasts are pointing. One should notice, too, that as early as March and April, the monthly year-on-year inflation rates in the Philippines had already exceeded the 2-4% target, hitting a high of 7.7% last month. It was only in May 2022 that a high probability was assigned to inflation exceeding the upper end of the 2-4% target for 2022 and moving toward 4% in 2023. Our response was a timid one with 25 basis points.

Since then, the private forecasters’ prognosis of inflation has gone up, some even exceeding BSP’s own forecasts which have been quite accurate. So, the forward guidance and assurances that the authorities are now ready for battle, could be vacuous unless the market continues to see them supported by actual decisive monetary action. The previous disconnect invariably de-anchored inflation expectations and actually contributed to more and higher inflation that we are seeing today.

Failure to read the writing on the walls and acting on them has so far cost us precious time and higher consumer prices. It is for the good of all of us if Medalla’s call finds hearing ears in the executive department.

Diwa C. Guinigundo is the former deputy governor for the Monetary and Economics Sector, the Bangko Sentral ng Pilipinas (BSP). He served the BSP for 41 years. In 2001-2003, he was alternate executive director at the International Monetary Fund in Washington, DC. He is the senior pastor of the Fullness of Christ International Ministries in Mandaluyong.