Monetary and fiscal policy response and recent developments

Recent Developments on Banking Industry: Impact on

Monetary & Fiscal Policy

Claro G. Ganac

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PAMANTASAN NG LUNGSOD NG MAYNILA

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I.Role of Government Policy

A. Macro-Economic Goals

B.Monetary Policy

C. Fiscal Policy

II.Recent Developments

A. Global

B. Domestic

III.Current Monetary and Fiscal Policy

IV.Conclusion

PRESENTATION OUTLINE

IntroductionIntroduction

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The Philippines has historically been affected by global and domestic developments that have caused the economy to experience downturns and crisis situations.

In the last 20 years, the country has suffered from: the 1997 Asian financial contagion, the dot.com stock market crash in the US corporate and financial scandals that saw the collapse of

Enron, Worldcom and Arthur Anderson accounting firm the 2008 US subprime mortgage credit collapse that

necessitated billions in dollars in bail-out packages Quantitative Easing initiatives

IntroductionIntroduction

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The US financial crisis escalated into a global economic recession that gripped most of Europe and other parts of the world from 2008-2002.

The Philippines was only marginally affected by the global crisis.

Banking reforms are now yielding fruit, particularly in terms of better risk management and consolidated supervision.

This paper is an exposition of the recent developments in the financial and banking sphere that have shaped the way official monetary and fiscal policies in the last decade.

Government Government and Fiscal and and Fiscal and Monetary PolicyMonetary Policy

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The Role of Government The Philippines has traditionally had a private enterprise

economy both in policy and in practice.

The Government undertakes socio-economic planning toward:

Creating and fostering economic institutions (such as business, banks, services, etc.)

Promoting economic progress and domestic industries

Providing basic infrastructure

Ensuring peace and order

Implementing social services and fostering employment.

Macro-Economic GoalsMacro-Economic Goals

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Robust and broad-based economic growth

High employment

Low and stable inflation

Strong external payments position

Sound and stable banking system

Improved budgetary and fiscal performance

The Role of Government A key role of

government is to manage and stabilize economic cycles particularly in times of recession.

Recession

Expansion

• Economic Output (GNP)

• Incomes• Employment• Prices

The Role of Government The economic policies used by the government to smooth

out the extreme swings of the business cycle are called counter-cyclical or stabilization policies.

This was based on the macroeconomic theory of John Maynard Keynes in the wake of the 1936 Great Depression.

Keynes argued that the business cycle was due to extreme swings in the total demand for goods and services. The total demand in an economy from households, business, and government is called aggregate demand.

Counter-cyclical policy involves increasing aggregate demand in recessions and decreasing aggregate demand in overheated expansions.

The Role of Government In connection with

developing sound market-based economic system and liberal and increased trade and commerce, it establishes policies in the fiscal and monetary realm to accomplish macroeconomic targets and goals.

It also uses fiscal and monetary policy to regulate economic cycles

Fiscal Policy

Fiscal Policy and Aggregate Fiscal Policy and Aggregate DemandDemand

Discretionary fiscal policy refers to the deliberate and discretionary manipulation of taxes and government spending to alter real domestic output and employment, control inflation, and stimulate economic growth.

“Discretionary” means the changes are at the option of the government.

Fiscal Policy Choices

Expansionary fiscal policy: used to combat a recession.

Contractionary fiscal policy: used to combat demand-pull inflation, excessive consumer spending and bank lending.

Income, employment are down

Inflation is up, property values too expensive, economy is overheated.

AGGREGATE DEMAND

Fiscal Policy Fiscal policy refers to management of the levels and

changes in the taxing and spending of the national government.

Management of these two variables alters the level of aggregate demand (AD) and aggregate supply (AS)

Taxes Expenditures Budget

Expansionary Policy

Tax rates Spending,Transfers

SURPLUS

ContractionaryPolicy

Tax rates,Collection

Spending,Transfers

DEFICIT

Expansionary Fiscal PolicyExpansionary Fiscal Policy

Expansionary Policy needed: a decline in investment has decreased AD, so real GDP has fallen, and also employment has declined. Possible fiscal solutions :

a. An increase in government spending, which shifts AD to the right by more than the change in G, due to the multiplier.

b. A decrease in taxes (raises income, and consumption rises by MPC times the change in income). AD shifts to the right by a multiple of the change in consumption.

c. A combination of increased G spending and reduced taxes.

d. If the budget was initially balanced, expansionary fiscal policy creates a budget deficit.

Contractionary Fiscal PolicyContractionary Fiscal PolicyContractionary policy: when demand-pull inflation occurs, a shift of AD to the right in the vertical range of AS, then contractionary policy is the remedy.

A. A decrease in G spending shifts AD back left, once the multiplier process is complete. Here price level returns to its pre-inflationary level, but GDP remains at full-employment level.

B. An increase in taxes will reduce income, and then consumption at first by the MPC times the decrease in income, and then the multiplier process leads AD to shift leftward still further.

C. A combined G spending decrease and tax increase could have the same effect with the right combination.

D. If the budget was initially balanced, a contractionary fiscal policy creates a budget surplus.

Financing Budget Deficits

Borrowing: (“Crowding out” effect) The government competes with private borrowers for funds, and could drive up interest rates; the government may “crowd out” private borrowing, and this offsets the economic expansion.

Money Creation: When the BSP loans directly to the government by buying bonds, the expansionary effect is greater.

MONETARY MONETARY POLICYPOLICY

MONETARY POLICYMONETARY POLICY

Monetary policy is defined as discretionary acts and directions undertaken by the monetary authorities or the government designed to influence:

the supply of moneythe cost of money (or rate of interest) of the availability of money

For achieving specific macroeconomic objectives.

Objectives of Monetary Policy

Price Stability

Economic Output and Employment

Financial Stability

Adequate Supply Of Credit For

Growth

Control Aggregate Demand

MONETARY POLICYMONETARY POLICY It is formulated and executed by Central Bank

(Monetary Board and the Bangko Sentral ng Pilipinas).

It refers to set of policy instruments by which the monetary authority controls:

• Supply of money (M1, M2 and M3)

• Reserve and liquidity requirements (for banks)

• Cost of money (or interest) through rediscounting window and lending operations

• Foreign exchange pegs/trading to control FX within target range (that supports both exports and imports)

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Effect of Money Supply on AggregateDemand and Supply

P

Q

M1 M2

Inflation}

Monetary Policy Monetary Policy ChoicesChoices

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Money Supply Interest Rate Condition

Expansionary Policy

Increase Decrease Easy Money

ContractionaryPolicy

Decrease Increase Tight Money

Effects Aggregate Demand;Inflation (consumer spending)

Aggregate Supply; Costs of Doing Business(production)

Current Global Current Global and Domestic and Domestic DevelopmentsDevelopments

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Philippine economic growth accelerated to 7.2 percent in 2013 despite Typhoon Haiyan (Yolanda) and other natural disasters. The country’s strong macroeconomic fundamentals shielded the economy from the weak global economy.

In 2013, Philippine financial markets experienced large volatilities as investors responded to the tapering of the US stimulus program. Stock and bond prices fell significantly in June, August and December 2013.

The outflow of portfolio investment contributed to the peso’s 12-percent nominal depreciation by year end.

However, confidence remained high and was recognized with a third credit rating upgrade to investment grade by international agencies (S&P, Moodys and Fitch).

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Domestic DevelopmentsDomestic Developments

Monetary and fiscal policy remained supportive of growth. With CPI inflation easing to 3 percent in 2013, policy rates stayed at low levels of 3.5 and 5.5 percent for the overnight borrowing and lending rates respectively.

Government finances continued to improve with better tax administration and efficient spending. Revenue collection grew by about 12 percent.

The banking sector has improved its rating levels to positive.

Standard & Poor’s said that the banking sector remained strong and will grow on the whole with improved performance in balance sheet and assets, as well as profitability.

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The International Monetary Fund (IMF), meanwhile, expected a monetary tightening cycle this year.

The IMF earlier scaled back its growth forecast for the Philippines to only 6 percent in terms of local output or the gross domestic product (GDP) this year.

The effect of further monetary policy tightening is not anticipated to affect current baseline forecast due to the pickup in fiscal spending and improvements in the external environment.

The BSP is expected to adoption more restrictive monetary measures to address the growing threat of inflation.

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In the past three Monetary Board meetings, the MB adopted a series of tightening moves that avoided a hike in interest rates but had the desired effect of moderating the buildup of price pressures.

So far, the reserve requirement ratio (RRR) of banks has been raised by 2 percentage points.

The BSP also raised the interest rate on its special deposits accounts (SDA) window by 25 basis points.

All these were designed to tame fairly high liquidity growth already averaging 28.4 percent in April.

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Domestic DevelopmentsDomestic DevelopmentsThe BSP effectively accelerates the implementation of

the Basel 3 accord for universal and commercial banks, including their subsidiary banks and quasi-banks.

A highlight of Basel 3 is the higher proportion of bank capital that is represented by common equity.

Under the BSP framework, Common Equity Tier 1 (CET1) ratio will be set at a regulatory minimum of six percent while the total Tier 1 ratio will be at a 7.5 percent minimum. This is on top of the current 10 percent capital adequacy ratio (CAR) requirement.

Both ratios are higher than the respective minimum under Basel 3.

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According to the MB, the earlier implementation of Basel 3 would put the Philippines alongside such jurisdictions as China, Australia, Hong Kong and Singapore.

Basel 3 is designed to improve the ability of bank capital to absorb losses, extend the coverage of financial risks and have stronger firewalls against periods of stress.

The staggered implementation of Basel 3 stretching through the end of 2018 to allow internationally-active banks time to raise capital organically.

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Domestic DevelopmentsDomestic Developments Banks have realigned their investment portfolio with the gradual

phase out of the BSP’s special deposit accounts (SDAs) that started in 2013.

The Special Deposit Accounts (SDA) facility consists of fixed-term deposits by banks and by trust entities of banks and non-bank financial institutions with the BSP.

It was introduced in November 1998 to enable the BSP to expand its toolkit in liquidity management.

Under BSP Memorandum 2013-021, trust departments were mandated to remove 30 percent of singular investment management accounts (IMA) parked on the SDA by July 31. A complete phase-out was carried out in November.

The trust departments of all banks will have to rechannel its funds and that of clients to time deposit and lending.

The Asian financial crisis gripped much of East Asia in July 1997 and almost led to an economic meltdown in the region.

As the crisis spread, most of Southeast Asia and Japan saw slumping currencies, devalued stock markets and other asset prices, and a precipitous rise in private debt.

Foreign debt-to-GDP ratios rose from 100% to 167% in the four large Association of Southeast Asian Nations (ASEAN) economies in 1993–96, then shot up beyond 180% during the worst of the crisis.

Economist Paul Krugman argued that East Asia's economic growth was the result of increasing the level of portfolio investment (also called hot money).

In recent years, financial turbulence and insolvency have become a major reason for economic recessions and downturns.

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Global DevelopmentsGlobal Developments


The 2008 credit crisis in the US is a landmark event that is

the precursor to more regulation and prudential supervision

of the banking sector around the world.

It saw the collapse of mortgage financing companies Fannie

Mae and Freddie Mac and underwriting brokers Bear Sterns

and Lehman Brothers, and the near bankruptcy of

insurer American International Group.

The International Monetary Fund blamed the financial crisis

of 2008 on 'regulatory failure to guard against excessive risk-

taking in the financial system, especially in the US.’

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Global DevelopmentsGlobal Developments In addition, fraud and investment malpractices have played a role

in the collapse of some institutions, which attracted depositors with

misleading claims about returns and yields.

Examples include the the accounting scandals perpetuated by

Arthur Anderson in the US in collusion with Enron and the collapse

of Madoff Investment Securities in 2008. At one time, Lehman’s

leveraging consisted of 30 times its equity assets.

Maintaining stricter supervisory and regulatory regimes for the

financial system in general and banks in particular is believed to be

a safeguard to such market risks of over-leveraging, fraud and

malpractices.

These have converged to changes in the regulation of financial

institutions and banks, particularly the Basel Accord.

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Global DevelopmentsGlobal Developments In the US, as a response to the prolonged US recession in

2008, the Federal Reserve (US Central Bank) implemented

the monetary intervention known as Quantitative Easing

(QE).

QE is an unconventional monetary policy used by central

banks to stimulate the economy when standard monetary

policy has become ineffective.

A central bank enacts quantitative easing by purchasing —

without reference to the interest rate—a set quantity of

bonds or other financial assets on financial markets from

private financial institutions.

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Global DevelopmentsGlobal Developments The goal of this policy is to increase the money supply rather

than to decrease the interest rate, which cannot be

decreased further.

The first round of easing called QE1 was initiated in

November 2008, 3 months after the Lehman Brothers

collapse. The round lasted for 17 months, and was

considered a success. Each month, the Fed spent $100

billion to purchase mortgage backed securities (total MBS

holdings $1.7 trillion)

The economy also appeared to have strengthened from

supported credit markets and liquidity provided to the private

sector.

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The Fed began the second round (dubbed QE2) from

November 2010 to June 2011. Distinct from QE1, this was to

stimulate economic activity.

Lasting 7 months, the Fed purchased US treasuries by

spending $85 billion each month in the purchase of long

term Treasury bonds.

This resulted in more reserve deposits (currency) flowing to

and the unloading of Treasuries in the private sector. QE2

had the effect of increasing business credit and increasing

asset prices.

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Global DevelopmentsGlobal Developments QE3: This round of QE launched an open ended MBS purchasing

program, which started at $40 billion a month and expanded to $85

billion monthly.

The federal funds were made available at interest rate near 0.

This was a stimulus program that relieved commercial housing

market of its huge debt risk, thus easing credit markets even

further.

On the whole, the QE interventions freed money into the financial

system which was meant to stimulate and expand bank lending

and consumer spending.

The implication is more important: It spurred the US stock

market and aided in its recovery, as well as freed liquidity for

banks and other investors to invest in portfolio funds that

were channeled to emerging markets, including the

Philippines.40


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Policy Response Policy Response to Global and to Global and Domestic Domestic DevelopmentsDevelopments

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Monetary Policy ResponseMonetary Policy Response The Philippine banking system has remained resilient despite the

heightened global financial uncertainty and financial shocks.

The BSP has been successful in using its regulatory clout to

manage the banking system and the macroeconomic and

monetary policy variables.

Through policy instruments and moral suasion, it has strengthened

the banking sector:

strong bank balance sheets with a return to profitability;

improvements in risk and liquidity management;

moves by banks into more profitable domestic business lines

such as consumer lending.

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Current Thrusts of the BSP on Monetary Policies

Managing capital flow surges (“hot money”)

Ensuring financial stability

Going the distance with structural reforms

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Monetary Policy ResponseMonetary Policy Response

The prudential measures put in place after the Asian crisis

also included:

instituting greater corporate governance and transparency,

upgrading risk management standards and

curbing excessive risk-taking of domestic banks.

These also cover strengthening banking institutions by

cleaning up non-performing assets and increasing bank

capitalisation through Basel 2 and 3 to create a buffer during

external shocks

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Monetary Policy ResponseMonetary Policy Response

The BSP pursued policies that continued to infuse

appropriate levels of liquidity to maintain the efficient

functioning of the financial markets and help avert the

shrinkage of domestic markets while keeping its eye on price

developments.

It has strengthened supervisory and regulatory systems and

stricter prudential regulation of banks and quasi-banks.

The objective is to create a steadily growing, adequately

capitalised, globally competitive significantly stronger

Philippine banking system.

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Monetary Sector Reforms Monetary Sector Reforms Continuing banking reform measures were worked out within the legislative

framework through the General Banking Law (GBL) of 2000 or R.A. No.

8791.

The law gives the BSP flexibility in supervising the banking industry and

has upgraded banking laws to meet global standards, including powers

and scope of authorities of banks, outsourcing of banking functions,

foreign stockholdings, and microfinancing loans.

The reforms will be complemented by the proposed amendments to the

Charter of the Bangko Sentral.

The amendments will reinforce the autonomy, authority and capacity of the

BSP not only to regulate and supervise the banking system but also to

more effectively implement monetary policy.

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Monetary Sector Reforms Monetary Sector Reforms

A specific amendment to the New Central Bank Act will among others relax

existing barriers to the fight against money laundering to eliminate fraud and

the unauthorized entry of foreign money that will disrupt money and liquidity

levels in the local financial system.

The BSP also seeks to give banks and regulators the right to examine FCDU

accounts under certain conditions.

The BSP is also encouraging the restructuring of the local banking industry. In

anticipating of ASEAN 2015 integration, domestic banks need to mobilize

sufficient capitalization and to strengthen risk management systems to

compete in a more challenging and globally integrated banking environment.

This strengthening can be assisted through mergers and acquisitions and

through greater participation of foreign financial institutions.

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Fiscal Policy ResponseFiscal Policy Response

In the Philippines, fiscal policy is characterized by continuous and

increasing levels of government expenditures and budget deficits.

During the Marcos era, pet infrastructure budgets, government

corporations and budget deficits were funded mainly by loans.

The first Aquino administration inherited a large fiscal deficit from the

previous administration, but managed to reduce fiscal imbalance and

improve tax collection through the introduction of the 1986 Tax Reform

Program and the value added tax.

The Ramos administration experienced budget surpluses due to

substantial gains from the privatization program involving the sale of

government assets and strong foreign investment in its early years.

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However, the implementation of the 1997 Comprehensive Tax Reform

Program and the Asian financial crisis resulted in a negative fiscal

position in the succeeding administrations.

The Estrada administration faced a large fiscal deficit due to the

decrease in tax effort and the repayment of the Ramos administration’s

debt to contractors due to the implementation of the fast-track power

plant projects.

During the Arroyo administration, the Expanded Value Added Tax Law

was enacted, national debt-to-GDP ratio peaked, and underspending

on public infrastructure and other capital expenditures was observed.

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This enabled the country to experience, after a long time, budgetary

surpluses. This enabled the Arroyo government to resume and expand

public infrastructure programs in 2007 up to the end of its term in 2010.

The robust infrastructure spending fueled the rise in GNP to over 7

percent in 2010.

During the early tenure of Philippine President Benigno Aquino, most

development projects were shelved or deferred, which resulted in an

anemic 3% GDP growth rate of the country in 2011.

In response, he instituted fiscal stimulus package consisting of cash

transfers (called Conditional Cash Transfer program) to boost the weak

economy and stagnant consumer spending.

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The government had a budget surplus in 2011 due to deferrals in

infrastructure spending. This policy contributed to the decline in GNP

during the year (3% in 2011) from 7.3 percent in 2010.

The Aquino administration’s fiscal policy revolves around it proactive

liability management agenda. This meant more prudence and control

in government borrowing.

As of end-2013, the country’s general government (GG) debt to GDP

ratio improved by 1.4 percentage points (ppt) from the previous year

and 0.5 ppt from the previous quarter to reach 39.2%.

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Fiscal Statistics

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Fiscal Statistics

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The country’s debt stock also continued on its healthy downward

trend. As of December 2013, the country’s Outstanding Public Sector

Debt (OPSD) was recorded at P7.65 trillion, or 66.3%of the country’s

gross domestic product (GDP).

The ratio decreased by 4.6 percentage points (ppt) from 70.9%, which

was recorded during the same period in 2012.

One of the centerpiece programs of the Aquino administration has

been the public-private partnership projects (PPPs).

Aquino recently reported the approval of 7 PPP projects which he

stressed represent key infrastructure that is needed for the Philippine

economy.

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The 7 PPPs are worth about P62.6 billion ($1.44 billion),

notably:

Daang Hari-South Luzon Expressway Link - P2 billion ($46.11

million);

Philippine Orthopedic Center modernization - P5.98 billion

($137.88 million);

Ninoy Aquino International Airport Expressway - P15.52 billion

($357.85 million);

Automated Fare Collection System (AFCS) for the MRT/LRT

systems - P1.72 billion ($39.66 million);

Mactan-Cebu International Airport Expansion - P17.5 billion

($403.58 million). 57

Conclusion

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Summary of Monetary & Fiscal Policy

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Fiscal Policy Monetary Policy

Definition

Fiscal policy is the use of government expenditure and revenue collection to influence the economy.

Monetary policy is the process by which the monetary authority controls the supply of money, often targeting a rate of interest to attain a set of objectives oriented towards the growth and stability of the economy.

Principle

Manipulating the level of aggregate demand in the economy to achieve economic objectives of price stability, full employment, and economic growth.

Manipulating the supply of money to influence outcomes like economic growth, inflation, exchange rates with other currencies and unemployment.

Policy-maker Executive Branch and Congress Central Bank

Policy Tools Taxes; amount of government spending

Interest rates; reserve requirements; currency peg; discount window; quantitative easing; open market operations; signalling

Monetary and fiscal policy response and recent developments

Documents

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