Challenges Facing the BSP in Conducting Monetary Operations under Excess Liquidity Diwa C. Guinigundo Deputy Governor Monetary Stability Sector Bangko Sentral ng Pilipinas

I. Excess liquidity and foreign exchange inflows II. Challenges to monetary policy III. Policy responses IV. Future policy directions Outline of Presentation

I. Excess Liquidity and Foreign Exchange Inflows

Domestic Liquidity ( Annual growth rate in percent ) Domestic liquidity growth strong, interest rates declining ‘04 ‘05 ‘06 ‘07 LIQUIDITY GROWTH (RHS) 91 DAY TBILL (LHS)

Loans Outstanding: Other Depository Corporations (ODCs) ( Annual growth rate in percent ) Credit growth is moderate

Domestic liquidity growth driven by growth in NFA Growth Rates (in%)Dec 2004 Dec 2005 Dec 2006 August 2007 M Net foreign assets Net domestic assets8.8(0.3)6.3(4.6) BoP(US$Mil) * *Jan-Sept 2007

Are the flows witnessed in recent years sustainable? Are the flows reversible? Are they volatile? Some issues on foreign exchange flows: The critical objective is to encourage more stable long-term flows in order to maximize the benefits of additional foreign capital

Current account surpluses rather than capital inflows are the main source of FX inflows Source: BIS background note for a BIS Working Party Meeting on Monetary Policy in Asia on 7 and 8 June 2007 in Bangkok

Emerging Asia: Balance of Payments and Reserve Accumulation (in percent of GDP) Source: IMF Regional Economic Outlook: Asia and the Pacific, April 2007

Philippines: Balance of Payments and Reserve Accumulation (in percent of GDP)

For the Philippines, net increases in the current account balance is largely due to remittances

Philippines: Main sources of FX inflows appear to be relatively stable Relative Magnitude and Volatility of Selected FX Inflows (2000 – 2006) Sources of FX Inflows% of GDP C.V. 2/ Overseas Filipinos Remittances 1/ Exports of Goods and Services Foreign Direct Investments Inflows Foreign Portfolio Investment Inflows Note: 1/ Coursed thru the banking system (Table 11 of SPEI) 2/ Coefficient of Variation = (Standard Deviation / Mean ) x 100%

Emerging Asia: Capital Flows Volatilities (in percent of GDP) Source: IMF Regional Economic Outlook: Asia and the Pacific, April 2007

Philippines: Capital Flows Volatilities (in percent of GDP) Note: Volatility is defined as the standard deviation of the change in capital inflow or outflow relative to GDP. Source: IMF Regional Economic Outlook: Asia and the Pacific, April 2007

Less vulnerable to shocks and “sudden stops” Persistent currency appreciation pressures, resulting in large reserve accumulation Implications of higher current account balances than net capital inflows: Strong liquidity and credit growth Downside risks:

II. Challenges in the Conduct of Monetary Policy

Conduct of monetary policy is more challenging  Capital inflows have increased pressures on currencies to appreciate  Surging capital inflows have enhanced liquidity growth, inflation pressures

Policy complications posed by capital inflows  Higher interest rates could address liquidity concerns but could induce more capital inflows  Lower interest rates may be consistent with a benign inflation outlook but could spur domestic liquidity growth

III. Policy Response

 Market-determined exchange rate policy  Building up reserves to temper foreign exchange market volatility  Foreign exchange liberalization measures  Prepaying a substantial amount of debt  Fine-tuning of monetary operations The BSP’s Policy Mix

Peso per US Dollar Rate Exchange rate policy has been flexible End-Sep ‘ Aug ‘

GIR has been increasing Gross International Reserves of BSP end-of-period ( in million US dollars ) End-Sep ‘07 $30.9 billion Gross International Reserves of BSP

 Increase in OTC purchases by residents without documentation  Increase in allowable outward investments by residents without BSP approval and registration  Imposed symmetric limit of 20% of unimpaired capital with an absolute limit of US$50 million on overbought and oversold positions of banks Foreign exchange liberalization : 1 st wave

Prepayment of Debt

Allowing trust entities to deposit funds with the BSP special deposit account facility Encouraging public and private pension funds and other government-owned and – controlled corporations to deposit funds with the BSP Allowing special deposit account placements as alternative compliance with the liquidity floor requirements for government deposits Fine-tuning of monetary policy instruments

Special Deposit Account (SDA) (in million pesos) SDA Levels May ‘07 222, 892 As of 22 Oct ’07 471, 943

RRP Levels 22 Oct‘07 199,895 Reverse Repurchase (RRP) (in million pesos) (Apr’07) 341, 137 (May’07) 240, 074

Domestic Liquidity ( Annual growth rate in percent ) INFLATION (right scale) LIQUIDITY (left scale) (Aug’05) 17.0 (Dec’06) 22.7 (Apr’07) 26.1 (Feb-Mar’06) 7.6 Aug ’ Aug ’07 2.4

IV. Future Policy Direction

Facilitate productive use of inflows Encourage private sector capital outflows Insure against sudden reversals in flows Improve BSP's ability to offset the effects of inflows Long-term approaches:

Encourage investments by Overseas Filipinos Facilitate productive use of inflows Overseas Filipinos (OFs) include: = Permanent Migrants + Overseas Filipino Workers (= temporary + irregular) Note: In 2006, the stock of OFs is estimated to be around 8.2 million (10% of the total population), of which 4.7 million are OFWs.

On encouraging investments by OFs (First wave: facilitating remittance flows) Promoted transparency and competition by issuing Circular no. 534 (remittance charges disclosure). Improving payment and settlement systems by approving setting up of local bank’s remittance centers & branches abroad, authorized rural banks to accept FCDs, approved interconnection of three (3) ATM networks, and approved use of new technologies as mode of remittance (e.g. internet and SMS) Promoted financial literacy campaigns among OFs/families What the BSP has done:

Foreign exchange liberalization Facilitate overseas portfolio investments by domestic investors Encourage private sector capital outflows

On encouraging private sector capital outflows through further FX liberalization: Phase 1: BSP Circular 561 (symmetrical limit of 20% of unimpaired capital [OS/OB positions] + increased outward investment by Philippine residents to $12B/year); BSP Circular 565 (allowed thrift banks to invest in FCD debt instruments) Phase 2: Simplifying documentary requirements for trade and non-trade; promoting cross-border transport of the peso; and facilitating derivative trading What the BSP has done:

Pursue BSP’s remaining P40B capitalization Pursue amendments to BSP Charter, to allow BSP to issue its own instruments Improve BSP's ability to offset the effects of inflows

Sound macroeconomic policy Provide high-quality, timely information to market participants Risk management through financial reform, strengthened supervision and regulation Pursue multilateral/regional insurance arrangements against sudden stops Ensure against reversals in portfolio flows

On insuring against reversals in portfolio flows Pursuing multilateral/regional insurance arrangements against sudden stops Philippine involvement in ASEAN+3 Regional Financial Cooperation (e.g. Chiang Mai initiative, Bilateral swap agreements, Asian Bond Markets Initiative, Economic Reviews and Policy Dialogue) Adopting risk management through financial reform, strengthened supervision and regulation MB Resolution No (approved the BSP’s implementation plans for Basel II) What the BSP has done:

Thank you.