Angelo Taningco
Economist, Treasury Group

The BSP’s Monetary Board has announced a 1 percentage point (pp) reduction in the reserve requirement ratio (RRR) to 18% effective 1 June. This follows the initial RRR cut that transpired in March. We think this is positive for economic growth as domestic liquidity and aggregate demand will be augmented. A 1pp cut in RRR is estimated to inject about P100 billion into the financial system. At the same time, the peso will face stronger depreciation pressures in light of more money supply circulating in the domestic economy. A sharper peso depreciation could very well stoke inflationary pressures.

The central bank has emphasized that the gradual reduction in the RRR is an “operational adjustment” (and not an adjustment in its monetary policy stance) that aims to bring down financial intermediation costs and make its monetary instruments more market-based. The double-digit level of the RRR is considered to be high in comparison to other countries, warranting the need to bring it down to single-digits over the medium-term.

As the RRR cuts are done in a gradual manner, we think this would unlikely lead credit growth to accelerate to a point that will lead to economic overheating. Against this backdrop, we still expect GDP growth for the full year to be close to the lower end of the government’s target range. However, we now see greater upside risks to our near-term inflation and dollar-peso forecasts. This is because market participants may likely expect a further depreciation in the peso following the RRR cut. A more rapid peso depreciation, we posit, would lead consumer price inflation to accelerate further especially in the context of rising global oil prices. Against this backdrop, we maintain our view that another policy rate hike for the year would likely take place.

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