ING Bank Manila economist Joey Cuyegkeng believes a few cracks are already showing in the country’s fast-growing economy, hinting of potential overheating down the line. This is despite the Bangko Sentral ng Pilipinas’s (BSP) repeated assurance that the economy can handle the pressure.
Cuyegkeng said strong liquidity conditions and loan growth, plus the most recent upside surprise to the September inflation print, add up and amplify the concerns of overheating in the local economy.
“These developments add to a growing list of data indicating the possible beginnings of overheating. The list includes imbalances—deterioration of the trade deficit and current account, acceleration in fiscal spending and a wider budget deficit,” the private economist added.
An overheating economy is one whose capacity to produce cannot keep up with the pace of its demand expansion. Inefficient supply allocations also arise, as stakeholders start overestimating the economy’s potential for further growth. Overheating in the economy could feed into a high economic growth that is unstable and unsustainable, and ultimately triggers a significant increase in the country’s inflation rate.
Latest data from the Central Bank showed cash supply in the country—broadly measured as M3—accelerated to 15.4 percent in August from the 13.5 percent in July. While the BSP does not give actual projections for the country’s M3 growth, officials earlier said they expect liquidity expansion to be around 9 percent to 12 percent for 2017.
The 15.4-percent acceleration in August, Cuyegkeng said, is also stronger than expected, per their current models. The economist said ING Bank anticipated only a marginal acceleration of M3 to around 14 percent in the month—still within their so-called sweet spot of noninflationary money-supply growth of 10 percent to 15 percent.
The strong bank lending was also flagged by Cuyegkeng, saying the 20.4-percent loan growth in August beat their anticipation of a moderation of credit expansion, as compared to the 19.7-percent increase in July.
“The acceleration we saw may partly reflect some frontloading of purchases ahead of the implementation of the tax-reform package that not only includes lower individual income tax and higher excise taxes for fuel and sweetened beverages, but also higher excise taxes on automobiles,” the economist said.
Higher inflation
The bigger indicator, however, is this week’s announcement of the Philippines’s September inflation rate at 3.4 percent—the highest in five months.
While these sharp growth trends in the monetary conditions of the Philippines are seen to reflect strong economic activity and likely represent a good GDP turnout for the second half of the year, Cuyegkeng said the flip side to this acceleration is that demand pull pressures on prices are likely to continue rising.
“The September inflation rate, together with the acceleration in monetary indicators, add other indicators that may presage overheating. The other indicators include imbalances in the economy—wider trade deficits, a current-account deficit and fiscal deficits, and a positive output gap since 2016,” the economist reiterated.
Cuyegkeng is not the first to warn the country about the potential risks of overheating, which is now showing its early signs and symptoms.
In February international credit watcher Fitch Ratings said the Philippines is still at risk of overheating and overinvestment “amid persistent high loan growth, particularly in the real-estate sector, as the industry has been a significant source of credit over the last five years.”
Singapore-based DBS Bank, in June, also said given the aggressive infrastructure overhaul, “there is a need to manage overheating risks in the economy”.
Moody’s Investors Service, in its June assessment of the local economic dynamics, also found a number of indicators pointing to overheating risks in the Philippine economy.
“While broad macroeconomic stability has been maintained so far, a number of metrics indicate material capacity constraints that signal a risk of overheating,” the credit watcher said.
Thus, Moody’s said it could only consider raising the country’s rating should the government succeed in defusing signs of prospective overheating in the economy and financial system, aside from improving the predictability and stability of the political climate.
IMF’s word
In early August the International Monetary Fund (IMF) said in the conclusion of its Article IV Mission in the country that while the country’s strong growth is broadly stable, economic managers should continue to be vigilant of overheating risks particularly attached to strong loan growth and investment.
“The combination of rapid credit growth, buoyant private investment and fiscal expansion could lead to overheating,” the IMF said.
“IMF staff team supports the authorities’ plans to raise infrastructure and social spending while avoiding overheating and preserving investor confidence,” the global monetary authority added.
Time to tinker
Thus, to curb the overheating risks and concerns, Cuyegkeng believes the Central Bank needs to pull the trigger and start tinkering with its monetary-policy levers before the year ends.
“We continue to expect that the BSP may need to implement a preemptive tightening at the December meeting to head off overheating in the economy. This would also address the need to possibly reanchor inflation expectations while preserving interest-rate differentials [in the wake of a likely Fed rate hike],” the economist said.
The Central Bank has been maintaining key policy rates unchanged since 2014.
In its latest monetary-policy meeting, the BSP’s Monetary Board decided to maintain the interest rate on the BSP’s overnight reverse repurchase (RRP) facility at 3 percent. The corresponding interest rates on the overnight lending and deposit facilities were also kept steady. The reserve requirement ratios were likewise left unchanged.
The decision was made on the back of a “manageable inflation environment”, albeit admitting that the balance of risks to the inflation outlook also continues to be on the upside. The BSP still expects inflation to fall within its 2-percent to 4-percent target for the year, particularly averaging at 3.2 percent for this year and in the next two years.
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