POST PRANDIUM: The unintended consequences of last year’s interest rate increase

FERNANDO FAJARDO

The Bangko Sentral ng Pilipinas’ (BSP) objective in increasing its policy interest rate by 1.75 percent overall from 3.0 percent in 2017 to 4.75 percent in 2018 was to bring down the inflation rate. How much of the decline in the inflation rate we are seeing now is due to this, we do not even know. What is clear though is that the rise in interest rate affected the demand for loans as reported by BSP, be it for business or consumption loan purposes.

The BSP in its recent statement said that outstanding loans of universal and commercial banks, net of reverse repurchase (RRP) placements with the BSP, grew at a slower rate of 15.3 percent in January from the 15.7 percent (revised) in December. Likewise, the growth in bank lending inclusive of RRPs decelerated to 14.4 percent in January from 14.8 percent (revised) in the previous month.

Loans for production activities, which comprised 88.6 percent of banks’ aggregate loan portfolio, net of RRP, increased at a slower pace of 15.5 percent in January from 15.8 percent in the previous month.

Similarly, the growth of loans for household consumption was lower in January at 12.7 percent relative to the 13.6-percent (revised) growth in December. The deceleration in credit card loans and motor vehicle loans as well as the contraction in salary-based general-purpose consumption loans offset the expansion in other types of household loans during the month.

The primary objective of the BSP’s monetary policy is “to promote price stability conducive to a balanced and sustainable growth of the economy” (Republic Act 7653). It does this now using the inflation-targeting framework of monetary policy as oppose to monetary aggregates targeting approach it used previously.

Inflation targeting is focused mainly on achieving a low and stable inflation, supportive of the economy’s growth objective. This approach entails the announcement of an explicit inflation target that the BSP promises to achieve over a given time period. Many developed countries also adopt this system and for the moment, their most common inflation target is 2.0 percent.

Presently, the Philippine inflation target is set by the BSP at 3.0 percent with an allowable upper and lower bound limit of one percent or 3 plus/minus one percent. The 4.0 percent upper bound was breached last year when inflation shoot up to 5.2 percent. Since 2010, the only other year when the upper bound was breached was in 2011 with 4.6 percent and 2014 with 4.1 percent. In 2015 and 2016, inflation rates were below the lower bound at 1.4 percent and 1.8 percent, respectively.

It is when the inflation rate exceeds the upper bound of the inflation target that prompts the BSP to raise its policy interest rate. This rate is BSP’s overnight reverse repurchase (RRP) rate, which at present is now at 4.75 percent. When this rate is raised, the other types of interest rates prevailing in the market will also move up such as the Treasury Bill Rate, the yields on bonds, and lending rates of banks. As a result of the rise in the RRP rate, for example, the monthly average Treasury bill rates has gone up from 2.15 percent in 2017 to 3.61 percent in 2018, Last January, it has gone up to 6.0 percent.

When interest rate goes up, demand by households and firms for goods and services, including investment, goes down. This leads to the decline in inflation rate eventually. However, this process take times to happen and the final effect is felt only after a year at least. We can say then that much of the decline in inflation rate from a high of 6.7 in September last year to 4.4 in January this year was caused more by the reversal of other factors that cause the inflation rate to rise other than excess demand.

The inflation-targeting framework of the BSP recognizes these other factors. These include inflation pressures arising from (a) volatility in the prices of agricultural products; (b) natural calamities or events that affect a major part of the economy; (c) volatility in the prices of oil products; and (d) significant government policy changes that directly affect prices such as changes in the tax structure, incentives, and subsidies.

Now you know that when we do something, there are always other consequences than will come beyond what we intended and that sometimes what we think as the result of our actions are really just the result of other things you did not do.