The central bank stated several reasons for the hold, one of which is that the latest inflation forecasts are not materially different from the previous forecasts in December.
Additionally, it mentioned that uncertainty over global economic policies and their impact on the domestic economy has increased significantly.
Interest rates are one of the tools the BSP uses to control the flow of money within the economy.
Briefly explained, high rates are intended to discourage borrowing for capital building or consumption, thereby reducing demand and cooling inflation. Lower rates, on the other hand, are presumed to encourage borrowing, stimulating the economy.
While this is the most widely known economic tool in the central bank’s arsenal, it also has a depreciative effect on the currency, especially if local rate cuts result in a narrowing of the differential between rates here and abroad.
To avoid this, the BSP has recently started to deploy another tool to help the economy grow, namely making changes to the Reserve Requirement Ratio (RRR).
The RRR is the percentage of bank deposits and deposit substitute liabilities that banks must set aside with the BSP. In other words, these funds cannot be lent out by financial institutions.
Where do we stand?
Although the BSP has implemented several cuts to the RRR over the past few years to boost liquidity, we note that, compared to ASEAN peers, the Philippines continues to have one of the highest RRRs at 7 percent versus Malaysia’s 2 percent, Singapore’s 3 percent, Thailand’s 1 percent, and Vietnam’s 3 percent.
Only Indonesia (9 percent) and Laos (8 percent) have higher ratios.
How does this help the economy?
For example, on Sept. 21, 2024, the BSP cut banks’ RRR by 250 bps, lowering it from 9.50 percent to 7 percent. We already saw the additional injectable funds from the RRR cut spur economic growth in the fourth quarter of 2024, with total loans registering a significant year-over-year (YoY) growth of 12.5 percent, higher than the 7.9 percent growth in the same period of 2023.
Granular data paints an even brighter picture, with consumer loans growing at a faster rate of 24.2 percent YoY, meaning the additional liquidity is making its way into the consumer sector—the main driver of the Philippine economy.
After the BSP decided to hold borrowing rates steady during its last policy meeting, the central bank indicated its intention to boost economic activity using RRR cuts instead.
Based on the BSP’s initial guidance, we expect an RRR cut of 200 bps within the first half of 2025, which will bring the RRR in line with the ASEAN peer average of 5 percent.
While we would like to believe that the BSP is taking a data-driven approach in determining the trajectory of interest rates, we also acknowledge that it must take measures to protect the peso against further depreciation.
As such, even though both inflation and economic growth data point to the need for lowering interest rates, the BSP is constrained from deviating too much from the Fed’s course.
However, it’s good to know that the BSP has more than one tool in its toolbox, and we believe that the plans for an RRR cut should uplift confidence on the local end, as it signals the BSP’s commitment to supporting economic growth.
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