FORMER Bangko Sentral ng Pilipinas (BSP) Deputy Governor Diwa Guinigundo warned economic managers of sweeping statements like “the worst is over” for the Philippine economy, saying misplaced confidence puts the government at risk of being blindsided by asset price inflation, reluctance of banks to lend and a deeper fourth quarter recession.
Guinigundo, a career central banker before recently retiring, particularly flagged BSP Governor Benjamin Diokno’s statement on Friday, saying the Philippines’s external accounts from July to September suggest that “the worst” is over for the economy.
Speaking at the Stratbase Pilipinas Conference 2020: “Rebooting the Economy Post-Pandemic: Cushioning the Long Emergency,” Diokno said: “As we monitor the impact of the pandemic on the external accounts, it can be observed that the effects were mostly felt during the second quarter of 2020, particularly during the months of April and May, as stricter lockdown measures were imposed by the government as part of its efforts to fight the spread of the virus. As we entered into the third quarter of the year, preliminary data from July to September suggest that the worst is over.’’
Guinigundo, however, said this should not be the basis of this statement, as these data were already captured in the dismal third quarter gross domestic product (GDP) of the economy and that the fourth quarter numbers are still unknown.
“Last Saturday, the media reported that the BSP cited the surplus in the balance of payments and foreign investments and recovery in overseas remittances as basis for saying ‘the worst is over.’ I should clarify, ladies and gentlemen, that these indicators have all been captured by the continued decline in the economic performance in the third quarter real GDP of minus 11.5 percent. I’m not sure these backward looking metrics can be considered as leading indicators for the last quarter of 2020,” Guinigundo said.
Aside from a weaker-than-expected third quarter GDP, some private economists are now saying that the fourth-quarter GDP is now shaping up to be worse than the 11.5- percent contraction in the third quarter of the year.
ING Bank economist Nicholas Antonio Mapa, for example, recently said that the fourth quarter GDP is expected to worsen from the third-quarter data as agriculture and real property damage from a string of violent typhoons is expected to shave off at least 0.1 percentage points off of GDP.
“It would be unrealistic to assume that we have already flattened the pandemic and economic activities are on their way to recovery. A resurgence can reverse any initial gains. This is a reasonable assumption because in the US and Europe and some parts of Asia the virus is coming back with a vengeance,” Guinigundo said.
This false sense of confidence carries with it some risks, Guinigundo said, including having mispriced risks in the market due to very low interest rates, not addressing the banks’ reluctance to lend and fuel the economy despite rate cuts and being unprepared for the fourth quarter slump.
Risk of asset bubbles
In their latest meeting, the BSP unexpectedly decided to cut interest rates anew by another 2 basis points, bringing the country’s interest rates to their record lows. This also brings the cumulative cuts made by the BSP to 200 basis points just this year.
Guinigundo said monetary policy should be “more circumspect” in dealing with extraordinary times as too much easing can compromise financial stability and foster mispricing of risks.
“Monetary policy should guard against itself. It is easy to be carried away with excessive easing of monetary policy and release the extraordinary amount of liquidity in the system, because the economy is not doing well in a deep recession. To me, the BSP has done enough,” Guinigundo said.
Economist and National Scientist Raul Fabella, who was also a speaker at the same forum, agreed with Guinigundo, saying the BSP may have cut its rates too much.
“The BSP has overdone itself in a sense. We are now in negative real interest rate territory and the unintended consequences of that is [something to be] careful about as we move forward,” Fabella said.
One of the major risks of this move, Guinigundo said, could be asset price inflation.
“Now, price stability is not the only mandate of the BSP. Financial stability is another, based on the new law. When we get interest rates too low for too long, that could lead to mispricing of risks, and we might be setting the stage for asset price inflation in the near future,” Guinigundo said.
An excessively high asset price inflation causes the formation of asset price bubbles. These bubbles arise when an asset class sees significant increases in their prices without underlying fundamentals to back up the price increase. When the market comes to their senses, this bubble may burst and cause economic disruptions.
Despite massive cuts, banks still won’t lend
The former BSP deputy governor also warned that despite the massive cuts from the BSP, banks are still not looking to lend.
Theoretically, central banks use interest rate cuts to boost the economy. Lower interest rate cuts translate to the market as lower financing costs, thereby creating an encouraging environment for borrowing and investment.
However, despite the cuts, bank lending continued to slow down in recent months.
Latest data shows that bank lending grew at 2.8 percent in September, weaker than the 4.7-percent growth in August. This was attributed to banks’ reduced tolerance for risk, decline in loan demand due, in turn, to weak business and income prospects and observed shift by non-financial corporates to alternative sources of funds.
Guinigundo also particularly cited the banks’ tighter lending standards, as seen in the BSP’s recent senior loan officers survey (SLOS), as indicator that banks are not lending as much as they are expected to.
“Banks have chosen to be procyclical. They tighten rather than ease their lending standards in this down cycle and lending rates remain elevated despite the accommodative monetary policy stance of the authorities… If this is to carry over to future periods, say the last quarter of 2020, or to 2021 and 2022, both capital formation and growth may actually be undermined,” Guinigundo said.
Confidence from the people
While Guinigundo said there are, indeed, signs of recovery, he said confidence is the “name of the game” in the coming months, and to restore confidence, the government should clearly demonstrate that pandemic and health management of the people is their priority.
Among his recommendations are repurposing some of the 2021 budget allocation and increasing the budget for health, education and infrastructure.
Fiscal policy “should not be timid” during this unique time. For monetary policy, he said BSP now has to monitor the effects of their cuts and talk to the banks to give credit.
“Unless this is effectively incredibly done, the economic scars of lost output of lost jobs, lost business weak consumer and business confidence will continue to take their toll on future economic performance,” Guinigundo said.