BSP sees capital flows as threats

Although emerging economies in Asia, including the Philippines, have coped well with capital inflows, Bangko Sentral ng Pilipinas (BSP) Governor Amando Tetangco has reiterated the need to closely monitor the funds surge.

Capital inflows, or money from foreign investors that flows into the local stock market, government securities and other money market instruments, remain to be the biggest threat to the economy, Tetangco  said.

Capital flows are being watched closely.  Tetanco said they  they have the tendency to raise the risks of asset price bubbles and the currency exchange rate which can also potentially undermine financial stability.

Equally important, because capital can just as freely and quickly flow out of the country, such sudden stops and abrupt reversals can threaten the real economy.

Tetangco explained that the surge of capital to emerging market economies is a major consequence of the financial crisis in the United States and the Euro Zone.

The easy monetary policy and risk appetite in advanced countries are “pushing” money out of their markets, and the favorable macroeconomic prospects of and interest rate differential with emerging market economies are “pulling” in the funds.

Analysts say that with the recent credit rating upgrades given by Standard and Poor’s and Fitch Ratings, the rate of capital inflows may increase.

Tetangco said emerging Asian countries have also used macro-prudential and capital account measures to manage capital inflows and contain the build-up of excesses in specific sectors and in the banking system.
They have employed macro-prudential policies as the first line of defense against financial stability risks, especially since the relatively shallower nature of their financial markets means that asset price bubbles could form rather quickly.

But he added that policymakers should also be cautious about the use of macroprudential measures.
“At the BSP, we look at macroprudential measures to help maintain stability in the financial system while we work on the further development of the financial market,” Tetangco said in an article in Emerging Markets, a Euromoney publication distributed during the Asian Development Bank annual meeting.

Tetangco stressed that “the nexus between macro-prudential and monetary policies should be duly considered.”

For example, Tetangco said macro-prudential restrictions on borrowing may affect expenditures in other sectors and, subsequently, economic output.

They may also weaken the transmission of monetary policy by influencing credit supply conditions.

“Monetary policy, in turn, may impinge on financial stability. Policy rates affect the cost of borrowing with subsequent impacts on how market agents decide on leverage and composition of assets and liabilities,” Tetangco said.

“Efficiency dictates that we should have a clear assignment of tools to policy objectives - monetary policy should be focused on ensuring price stability, and macro-prudential tools should be used to manage potential build-up of systemic risks.

In many instances, both policies can be mutually reinforcing, such as when they both lean against the business and financial cycles,” Tetangco explained.

Since 2010, Tetangco said that emerging market economies have been receiving more than a trillion dollars of capital flows a year, with emerging Asia getting about half.

“While the potential benefits of capital flows are well recognized, the size and volatility of these flows create risks to financial stability. They also present challenges to the conduct of monetary policy,” Tetangco said.
In most of the emerging economies, he said the amount of capital exceeds the absorptive capacity.

“Liquidity management becomes a huge hurdle to monetary authorities. Subsequently, there is a risk of build-up of financial imbalances due to rapid credit growth and rising asset prices,” he added.

“The reversal of flows is the other side of this risk.  There is no doubt these may have a destabilizing impact on emerging market economies,” he said.

Tetangco stressed that the BSP has tried to make effective use of monetary policy instruments.
“We were able to reduce policy rates because of the benign inflation environment, and we have rationalized our reserve requirements. In general, Asian currencies have appreciated as a consequence of the flows. Sterilized interventions were mainly to temper volatility of currency movements, although these actions have resulted in rising costs of stabilization. In the case of the peso, the appreciation has been at 9 percent since 2009,” Tetangco said.

Although capital inflows to Asean countries including the Philippines have increased over the past few years, Bank of America Merrill Lynch (BofAML) said that the magnitude and volatility of inflows have not, however, reached previous peaks.

The US-based banking giant even cited the moves done by the Bangko Sentral ng Pilipinas (BSP) which include cutting SDA rates, banning foreign funds in special deposit accounts, and imposing a cap on banks’ non-deliverable forward holdings to temper capital inflows and ease upward pressure on the peso.

“Overall, we see further risk of more FX intervention and macro-prudential measures to contain bubble risks, while capital controls are less likely,” BofAML said.

But the BSP has said that should capital flows reach high point, possibly resulting to disruptions in asset prices and inflation, they are ready to combat these flows.

source:  Malaya