Addressing High Inflation in the Philippines – the Role of Policy Mix

The Philippine economy has witnessed a robust performance over the past few years. However, such performance was accompanied by high inflation which became the main issue of concern. Despite some moderation from its peak of 8.7 percent in January 2023, headline inflation was 6.0 percent for the full year of 2023 while core inflation recorded a notable increase from 3.9 percent in 2022 to 6.6 percent in 2023.

What is driving inflation in the Philippines and how can the authorities utilize the “all-of-government” approach to combat inflation?

Key drivers of inflation in the Philippines

In general, inflationary pressures arise from a combination of demand-side (such as strong economic activities) and supply-side factors (such as increases in wages and commodity prices). A 2023 study conducted by the ASEAN+3 Macroeconomic Research Office on the drivers of Philippine consumer price index (CPI) inflation found that Philippine inflation was mainly driven by supply factors in 2022. However, thanks to the positive output gap, demand factors have become the main driver in 2023 (Table 1).

The rise in headline inflation in 2022 was largely driven by external supply factors such as surges in international commodity prices due to global supply chain disruptions and depreciation of the local currency. However, the persistence of high inflation in 2023 was mainly due to domestic demand factors, including a positive output gap thanks to robust growth performance and second-round effects induced by minimum wage hikes and expectations of persistently high inflation. At the same time, local supply shocks, such as typhoons, animal diseases, and other natural disasters, also contributed to the high inflation (Figure 1).

Meanwhile, both demand and supply-side factors continued to influence prices in the Philippines over the past two years, leading to high and persistent core inflation which excludes selected volatile food and energy components.

“All-of-government” policy mix

Having an in-depth understanding of the country’s inflation dynamics and the underlying drivers is vital to the setting of policies for the Philippine economy. In particular, the empirical results support the Philippine authorities’ “all-of-government” approach, which comprises both monetary and non-monetary measures, as it was timely and appropriate to curb with persistently high inflation, which were driven by buoyant demand and supply shocks, in 2022-2023. Aided by a moderation in international commodity prices, monthly headline inflation has declined from its peak of 8.7 percent (year on year) in January 2023 to 2.8 percent in January 2024.

Our findings showed that demand-side factors dominated in driving inflation in mid 2022 through 2023, which implies that the use of demand management policy – tightening stance of monetary and fiscal policy – was warranted. Between May 2022 and end-2023, the Bangko Sentral ng Pilipinas (BSP) tightened monetary policy aggressively by raising the policy rate ten times, from a historic low of 2.0 percent to 6.5 percent, which was deemed timely and appropriate.

As growth is projected to remain strong in 2024, the BSP should maintain a hawkish bias and stand ready to tighten the policy rate further if inflation becomes more persistent than expected. The ongoing fiscal consolidation also complements the tightening monetary policy stance in curbing high inflation.

Meanwhile, the contribution from supply-side factors to the high inflation rates was far from negligible. Most notably, prices of key food items, such as rice, onions, sugar, eggs, and pork, have surged to unprecedented levels due to a shortage of domestic supply. The surge certainly would call for the use of appropriate supply-side (or non-monetary) measures to help ease supply constraints.

In the short term, import restrictions should be relaxed by lowering import tariffs, speeding up the administrative processes required for importation, and  allowing for more imports of food through  market. These relaxations should remain in place subject to developments in domestic supply and prices.

In the medium to long term, the country should promote a stronger agricultural sector and a more resilient domestic food supply chain to reduce fluctuations in food prices and enhance food security. Specifically, it would be beneficial to introduce institutional reforms, such as land consolidation, enhancement of farmers’ access to financing, introduction of modern farming and innovation through the use of technology, and improvement in supply chain.

Amid the battle against high inflation, the government can help ease the pain of those most affected through targeted subsidies to the vulnerable groups. Compared to broad-based subsidies, the existing subsidies targeted for the lower-income groups are more appropriate as such targeted subsidies can help mitigate the adverse impact of inflation on the vulnerable groups without undermining fiscal sustainability.

Thanks to the use of policy mix, the Philippine authorities have taken a balanced approach in their attempts to tackle high inflation in recent years. However, the battle is not over yet as there are likely to be more shocks ahead. Supply side factors will continue to play a part as important determinants of Philippines’ inflation dynamics going forward. The authorities should remain vigilant and continue to address challenges which may arise from heightened uncertainty in the global economy, geopolitical conflicts and climate change.

Source: AMRO

PH likely to hit growth targets but risks cloud outlook – AMRO

Philippine economic growth will likely rebound this year and further accelerate in 2025, the Asean+3 Macroeconomic Research Office (AMRO) said in their report.

"The Philippines will benefit from the upswing in terms of the external demand and also the recovery in tourism," AMRO chief economist Hoe Ee Khor told a briefing.

Gross domestic product growth moderated to 5.6 percent last year, missing the government's 6.0- to 7.0-percent target.

AMRO maintained its 2024 growth forecast at 6.3 percent, saying that a strong recovery in domestic consumption would be one of the key drivers.

For next year, economic growth is expected to pick up to 6.5 percent.

Both projections fall within the government's recently-revised targets of 6.0-7.0 percent for 2024 and 6.5-7.5 percent for the following year.

Within the Association of Southeast Asian Nations, AMRO said the Asean-6 economies of Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam would continue to anchor regional growth by expanding 4.9 percent and also contributing an average of 10 percent to global growth.

"These economies are thus poised to account for a larger share of the regional and world economy by the end of the next decade," it said.

A rebound in merchandise exports as well as firm domestic demand are expected to continue driving Asean growth.

"Growth is forecast to be maintained in 2025 as global economic prospects improve and economies converge toward potential growth," it added.

As for the Philippines, AMRO warned that the outlook was clouded by various risks and challenges.

"In the near term, growth prospects are relatively robust, but high inflation is a risk, especially as a result of local supply shocks in the food sector and the impacts of geopolitical conflicts on international energy prices," it noted.

These will put pressure on inflation, dampening domestic demand.

There is also the risk of an economic downturn among key trading partners and fluctuations in global financial markets.

"Looking at the longer term, growth potential will largely hinge on the economic scarring effects of the pandemic, the pace of infrastructure development, and heightened geopolitical tensions between China and the United States," AMRO said.

The country could also suffer from increasing social and economic costs due to global climate change, which requires an "urgent need for a comprehensive strategy to foster resilient, sustainable, and inclusive long-term growth."

As for inflation, AMRO still expects it to fall within target at 3.6 percent this year and 2.9 percent next year.

"I think there's a slight risk this year because of the synchronized upswing in the global economy," Khor said.

Consumer price growth rose to 3.7 percent last month, from 3.4 percent in February, but still fell within the 2.0- to 4.0-percent target of the Bangko Sentral ng Pilipinas.

AREO2024_Launch_Deck_20240407_To-Use

.pptx

Download PPTX • 9.42MB

Source: Manila Times

Prices expected to remain elevated until Q3

The Bangko Sentral ng Pilipinas (BSP) sees inflation quickening further and staying above the two to four percent target until the third quarter due to the negative impact of weather conditions on agricultural production.

The BSP said that inflation remained within the target range, averaging 3.3 percent in the first quarter, due largely to negative base effects.

“However, inflation could temporarily accelerate above the target range in the next two quarters of the year due to the possible adverse impact of adverse weather conditions to domestic agricultural output and positive base effects,” the central bank said.

The risks to the inflation outlook also continue to lean toward the upside, according to the BSP.

“The upside risks to the inflation outlook could emanate from higher transport charges, higher prices of food commodities facing supply constraints, increased electricity rates, higher global oil prices, and implementation of a legislated increase in the minimum wage,” it said.

Headline inflation edged higher at 3.7 percent in March from 3.4 percent in February. It marked the fourth straight month that inflation stayed within the two to four percent target band. It was also within the BSP’s forecast range of 3.4 to 4.2 percent.

“Looking ahead, the Monetary Board will consider the latest inflation outturn in its upcoming monetary policy meeting on April 8. The BSP also continues to support the national government’s non-monetary measures to address supply-side pressures on prices and sustain the disinflation process,” the BSP added.

The central bank has kept interest rates steady since its off-cycle hike of 25 basis points in October 2023. From May 2022 to October 2023, the BSP tightened borrowing costs by a total of 450 basis points, bringing the key rate to a near-17-year high of 6.50 percent.

Aris Dacanay, economist for ASEAN at HSBC, said the consumer price index (CPI) could breach the target this April before returning to the two to four percent range in August.

“The numbers are consistent with our view that headline CPI will eventually breach the central bank target in the second quarter of 2024, which may, perhaps, result in some market jitters,” Dacanay said.

“Looking closely, however, the rise is mostly due to unfavorable base effects. Once these base effects wear off in August, inflation should immediately return to within the BSP’s target band,” he added.

Dacanay noted that base effects are coming from rice prices as global prices rose sharply in August and September last year.

Rice inflation rose 24.4 percent in March, the fastest pace since 2009 and contributed 2.2 percentage points to overall headline inflation.

“When we hit August this year, base effects should turn favorable, leading to a significant deceleration in headline inflation,” Dacanay said.

“The good news is that this spillover seems to be benign so far, with core CPI easing year-on-year. This showcases that monetary policy is in the works and that there is no impending need for the BSP to raise policy rates further,” he said.

Core inflation, which strips out volatile prices of food and energy items, slowed to 3.4 percent in March from 3.6 percent previously. Core inflation has been slowing down for the 12th consecutive month.

Dacanay expects the Monetary Board to keep policy rates unchanged anew at its second rate-setting meeting on April 8.

Source: Philstar