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BusinessWorld reported last Wednesday that Finance Secretary Sonny Dominguez announced the National Government’s plan to “tap the US bond market before rates skyrocket.” Secretary Dominguez did not elaborate during his interview with Bloomberg Television’s Kathleen Hays but in the congressional hearing in August 2020, the Government disclosed its plan to raise some P3 trillion or $62 billion from both domestic and international sources.
It would be a smart move for the Government to return to the US capital market but it should do it fast. The Philippines had impressed investment bankers and fund managers before the pandemic with, one, its excellent record of undertaking policy and structural reforms that has endured for 25 years; and, two, positive macroeconomic outcomes. Our past fund-raising activities were always capped by tight spreads and oversubscriptions.
Today’s growth narrative is definitely less exciting. But in online investment roadshows, last year’s dismal performance of a 9.5% contraction is something that could be explained. The weak public health system is a legacy issue and definitely, a work in progress. We could also make up for the delays in the vaccine rollout. These reasons are matters of governance and if the Administration is serious about leaving a good legacy in the last quarter of the game, economic managers can propose appropriate changes in leadership in the health and other concerned sectors. If the Palace accepts, the announcement by the Presidential Spokesperson could attract more than a hundred thousand hits.
It can also be conveyed to prospective investors that the forthcoming 2022 national election would be an occasion for renewed hope and expectation.
But the global economy and financial markets have become more complicated, as the April 2021 releases of the International Monetary Fund’s (IMF) World Economic Outlook (WEO) and Global Financial Stability Report (GFSR) would show. Stronger recoveries from the pandemic are now more apparent in the US, UK, and other advanced economies (AEs) and these should usher in a stronger rebound in the global economy in 2021. The positive assessment of AEs was based on, one, the successful vaccine programs; two, business adaptation to the challenges of lockdown through digital platforms and innovative logistics; and, three, US President Joe Biden’s $1.9-trillion fiscal stimulus package.
We are now looking at higher global growth of 6% this year and 4.4% in 2022, against the January 2021 WEO forecasts. This upgraded outlook did not come cheap. The Fund claimed that governments around the world spent $16 trillion in pandemic and economic mitigation without which, the global economy could have shrunk instead by 10% in 2020.
But in her blog, IMF chief economist Gita Gopinath admitted that “the global community still confronts extreme social and economic strain as the human toll rises and millions remain unemployed.”
The WEO equated the cost of the pandemic to wider income inequality. Some 95 million more people descended into extreme poverty in 2020. This is expected to be felt more acutely in emerging markets and developing economies (EDMs) where the initial success in mitigating the business fallout from the pandemic may not likely be replicated. Their economic scars are expected to be deeper than those in the AEs.
This is the essence of divergent economic recoveries.
Following this trend, a key issue found in both the WEO and GFSR is the anticipated increase in interest rates. For EDMs, the Fund described such anticipation “with trepidation.” The reason is quite obvious. They are faced with slower economic recovery due to their weak pandemic management and vaccine rollout. Their fiscal space is rather limited. With shaky economic prospects, their external payments position may be challenged by a possible drying up of capital flows. With the prospects of higher interest rates in the AEs, EMDs will have to balance the need for matching US interest rates and the need to sustain monetary policy support to their own rebound. Financial market stability could be compromised if the balancing proves wrong.
This is the peril of divergent economic recoveries.
For the Philippines, as for other EDMs, “what matters is the reason for the rise in US interest rates.”
There are both good and bad reasons for interest rates to climb and their impact on EDMs like the Philippines can range wide.
When the reasons are benign like higher job creation in the US and accelerated rollout of vaccines all over the county, foreign investors in the Philippines may be expected to bring in more capital, both portfolio and direct. It’s risk on, and even Filipino resident investors could share their optimism and we should see demand for both equities and bonds further expand. This is a balance of payments (BoP) — positive because with stronger economic activities in the US, its trading partners stand to benefit. Exports and imports increase, demand for Filipino workers improves with higher OFW remittances, capital and financial accounts both capture renewed foreign investment sentiment. This is the healthy type of BoP, not the type that is driven by weak market sentiment and animal spirit. This is when production is down so imports are low; demand for the dollar is weak so the peso is strong; foreign debt increases so the proceeds beef up the gross international reserves.
If interest rates spiral up due to higher inflation in the US, the effect on the Philippines could still be benign, or on balance, constructive. It is benign because it reflects optimistic market sentiment about the economic outlook of the world’s biggest economy. The prospects for recovery could be clearer for the country’s propensity to consume and invest so that those macroeconomic indicators including domestic interest rates, exchange rate and capital flows are moving in the right direction.
However, when interest rates in the US or in Europe start exhibiting correlation with hawkish central bank actions, or expectations of more hawkish monetary policy, that could be harmful to EDMs including the Philippines by driving up domestic interest rates. Funding the budget and development becomes costly.
Fund research also shows that a monetary policy surprise consisting of one percentage point increase in the US Fed, for instance, tends to cause one-third of a percentage point increase in long-term interest rates in the average emerging markets, or two-thirds of a percentage point in an emerging market with speculative credit rating. The Fund documents that this quick development could cause, all others being equal, capital outflows from emerging markets. Currency depreciates and inflation might act up.
As early as the beginning of 2021, inflation has started to climb in the Philippines. First quarter inflation averaged 4.5% compared to the official target of 2 to 4%.
While higher inflation remains supply driven, if second-round effects are triggered, and inflation expectations are disanchored, monetary policy will have to respond. This is the reason why monetary authorities should normally conserve their ammunition. Should interest rate adjustments become necessary, we would not have to do more. That could upset the real sector.
In reality, other factors may also be in operation. Rising term premium would reflect uncertainties about US’ future inflation, debt issuances and bond purchases. We can afford to wait because interest rates in the US and other AEs remain low. They are bound to climb as the recovery gains more traction. Market sentiment against emerging markets, specifically the Philippines, could gather momentum as vaccines remain elusive for massive, or even targeted, vaccination. Our failure in neutralizing the virus does not exactly inspire market confidence that would allow us to maintain monetary policy setting longer.
To reduce uncertainty, central banks in big economies should help by providing clearer guidance through transparent communication about future monetary policy. This important piece of information figures prominently in every central bank policy meeting. What happened in the Philippines in 2020 was consistent with the Fund’s analysis that “economies with more transparent central banks, more rules-based fiscal decision-making and higher credit ratings were able to cut their policy rates by more during the crisis.” Our monetary policy has been traditionally transparent and independent. Fiscal policy is not only responsible and transparent, but it also observes fiscal and debt sustainability metrics. Our credit rating is relatively high as we were about to reach at least an A- before the pandemic.
But we should not expect a zebra when we hear hoofbeats. The unseen virus has undermined most of our previous buffers during this pandemic.
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.