Technocrats quietly fortify institutions as Filipino politicos bicker 338.0

Technocrats have been asked to temporarily govern Greece and Italy as the professional politicians seem fearful of doing the necessary and lose votes.

We are fortunate that Filipino technocrats in the economics sphere like Finance, the Bangko Sentral ng Pilipinas (BSP) and Budget and Management are working well with President Aquino even as the political sphere of governance is roiled among politicos.

The surprise news is the additional paid-up equity of PhP 10 billion remitted in early November for the BSP. The next three annual installments totaling PhP 30 billion is committed and completes the legally mandated PhP 50 billion BSP capital legally mandated as of 1995.

Yet, from the news, three reports on the economy that is managed by technocrats were made last week that, to me, had a strange sequence:

1. On Friday, the Peso closed at 44.005 against US$1 after a quick devaluation of about ₱0.70 within the week,
2. On Friday, as the Inquirer reported, the BSP expects November inflation to range between 4.5% – 5.4%, October was 5.2%, ranging above the upper band of the target 3% – 5%, and
3. On Wednesday, the BSP hinted that their will be no change in guiding interest rates.

Is the BSP already a credible inflation fighter?

This is strange to me because the BSP and the technocrats would have had the expected inflation figures on hand by Wednesday and thus the proper announcement, at the least, ought to have been the possibility of an upward adjustment in interest policy rates.

Also, the only way for such a large devaluation within the week to happen is if the BSP did not sterilize peso payments of the week’s forex purchases even as the US$ strengthened as safe haven from Eurozone contagion.

The effective one week devaluation of 1.9% would have created upward inflation pressure of 0.3% – 0.5% based on net import intensity that will lag by 3 – 6 months from the inventory cycle leadtime.

This strange sequence may merely be a coordination problem. Still, the confusion makes reading policy – as rational expectations – murkier.

Transparency – as a way to manage rational expectations – is one of four key building blocks of classic inflation targeting that the BSP has announced as its monetary policy framework.

The inconsistency I noted above makes policy less transparent – see some discussion in rules vs. discretion debate in Taylor below.

It does not help to build the BSP’s credibility as inflation fighter that takes years of consistent action to acquire – much more than an announcement of inflating targeting as policy framework. Strangely sequenced news reported as above do not help.

I have made this same statement in an earlier post, Bangko Sentral Needs More Credibility as Philippines Inflation Fighter in April 2011.

In this linked April post, I discussed some sources of inflation as stressed by different scholars and the common policy problem of time inconsistency that the BSP is often guilty as with the past week.

Technocrats fortify the Bangko Sentral and the Peso

Still, beyond these operating issues, technocrats in the Aquino administration, including those of the BSP, are quietly fortifying the institutions of central banking and the Peso.

These stronger institutions will help the Philippines weather the effects of global recession and financial contagion while mitigating inflation.

Budget Sec Butch Abad announced, in a news report in Manila Standard on November 19, 2011, that the government has paid-up Php10 billion as equity for the Bangko Sentral in early November.

After a 19-year delay, additional installments of Php10 billion for each of the next three years will bring the BSP’s paid-up equity to the PhP50 billion legally mandated by its Charter, R.A. 7653 by 1995. With this commitment, I think the BSP can now book a Subscription Receivable on its equity.

We need to thank Finance Sec Cesar Purisima for adroit economic, tax collection and treasury management that is leading to an increase in government cash balances that allowed the government investment.

Likewise, Governor Amando Tetangco, despite a heart bypass, needs to be acknowledged for renewing his appointment and pushing for such a top-up investment to strengthen the BSP.

In compliance with its charter, R.A. 7653, the BSP’s unaudited Balance Sheet and Income Statement are now published, unlike in 2009, at the BSP website though still barely meeting the 90-day legal requirement.

One bonus: one proof that the BSP has gained credibility as inflation fighter is when Filipinos believe that the peso stops going through a cycle of devaluation. And the test is if investors in public-private partnership waive insurance and guarantees from foreign currency risk.

Technocrats prognosis: Philippines suffering from Dutch disease

I have always believed and confirmed in SYNTHESiST that the BSP, as with the DFA, has among the strongest technical teams in the government – now Asst Gov Cyd Amador already noted in 2007 the “Dutch Disease” symptoms in the economy. (More of this in a future post.)

Yet four years later, this key insight that I had a much earlier anecdotal evidence coming from industry, evidenced among others by the hallowing out of manufacturing, has not been acted upon by the BSP and the government.

SYNTHESiST, innovation, monetary policy and the Bangko Sentral

Source: Bangko Sentral website: http://www.bsp.gov.ph/. Click image to enlarge.

As personal advocacy, SYNTHESiST has been monitoring the Bangko Sentral through Innovator Peso(with more than 20 posts in this archive thus far) in support of a stable peso that facilitates long gestation innovation projects.

On our second month on March 2009, the post Introducing Innovator Money [later Peso] listed this BSP Watch as an important task. We already noted the issue of structural unemployment and speculating on the BSP’s version of the Taylor Rule.

From 1992, The Bangko Sentral‘s paid-up capital was only PhP10 billion. I suspect, all this equity was used up by this year in slowing down the rise of the peso.

I guessed in previous posts (and Facebook Status) that the BSP equity position had deteriorated badly hence the need to pay up on the equity.

In fact for 2011, from the Table at right, the unaudited financial statements showed that PhP 102.81 billion (121.19 – 224.0) has been lost in the year to July 2011 leaving a total paid-up of Php121B on Total Assets of Php3,506B.

With about PhP 325 billion debited to international reserves from forex purchases and PhP 200B credited to the SDA in the next two months to September to partially sterilize the purchases as the peso strengthened, the equity position could only have worsened.

I first noted this government violation of the BSP Charter in a blog post on October 9, 2009 – Filipino Taxpayers, Be Ready for a Possible Reserves Grab at the BSP.

I also noted in a previous SYNTHESiST post on May 25, 2009, Is the Bangko Sentral in Trouble?, that the BSP lost a similar P102 billion from its equity in 2007 while slowing down the peso rise.

The Dual Mandate of the BSP and its technocrats’ interpretation on the ground

Like the US Federal Reserve, the BSP has a dual mandate of price stability, i.e. fighting inflation, and support for growth (that is not specific to increasing employment).

Apparently from its response, slowing down peso appreciation is the BSP’s interpretation of meeting the “supporting growth” mandate on its charter. This mainly works on the asset side of its Balance Sheet through participation in foreign currency markets, i.e. purchases of US$.

Sterilizing these US$ purchases to slow down any peso appreciation involves liquidity mopping by buying the peso thus released that is now built up in its Special Deposit Account (SDA) in the equity side of its Balance Sheet.

With the SDA account growing from PhP 1.5 trillion in July 2011 to PhP 1.7 trillion in September, the cost of sterilizing the additional PhP 200B (though the peso weakening lets the BSP make money) required the long-delayed equity infusion above.

On Facebook, I re-posted a two-year old SYNTHESiST blog post from October 9, 2009 – Filipino Taxpayers, Be Ready for a Possible Reserves Grab at the BSP – where I reported the insufficient equity of the Bangko Sentral of only PhP10 billion where previous Presidents from 1992 violated the BSP Charter R.A 7653.

Indeed, unlike the US with its Federal Reserve, central banks of countries who use third currencies for international trade can go bankrupt if they follow wrong-headed monetary policies.

The Philippines did have that experience in 1992 when the old Central Bank (CB) of the Philippines was effectively shut down after being bankrupted by behest loans from Marcos cronies. Replaced by the current Bangko Sentral, the CB’s bad debts were kept in a “bad bank” until extinguished in the early 2000s by dividends from the BSP.

I am happy the Aquino Administration and its technocrats finally complied with a necessary, timely and legal mandate to fortify the BSP and rebuild the Peso from its foundation up.

Data extraction as November 25, 2011. Click image to enlarge.

Independent Central Bank ran by technocrats is linear descendant of the gold standard

As I wrote in an older post on November 2009, Independent Central Bank: The Modern Gold Standard, when the currency is fiat money that is not directly backed by gold, an independent central bank is the linear descendant of the gold standard.

With 90-day old financial statements and missing data like equilibrium real interest rate, I tried to build a matrix of forensic data to understand what makes our Bangko Sentral tick.

In the matrix above, I use proxies like US T-Bill as proxy for equilibrium real interest rates and long-time unemployment of >7% as indicating under-capacity utilization as a measure of potential GDP and try to fill the spcs and connect the dots.

I studied writings by two technocrats, both Republicans,  but with different views on how to run a central bank, Ben Bernanke and John Taylor, in deriving my own insights.

Ben Bernanke, T Laubach, F Mishkin and A Posen on Inflation Targeting (1999 Princeton). Click image for Amazon link.

Inflation Targeting.  Before becoming Chairman of the US Federal Reserve, Professor Ben Bernanke was a keen student of the 1930s Depression and of inflation targeting.

I also have personal experience having lived in the pioneer country-developer of a mainly rule-based style of inflation targeting, New Zealand, and studied its importance for innovation as small country.  I blogged about John Singleton’s Innovation + Independence: The Reserve Bank of New Zealand in April 2009.

Even then, their is a clear relationship between inflation and the intermediate variables of  (a) GDP growth and employment, (b) interest rates, and (c) exchange rate differentials with key trading partners.  This relationship is reinforced as these variables were they key performance metrics in the Bernanke et al country case studies.

The Bernanke book at left highlighted its consideration of rational expectation as foundation to inflating targeting thus, transparency goes hand-in-hand with its adoption.  Inflation targeting will not work if citizens do not find their ventral bank credibly transparent.

Unfortunately, the dual mandate of the US Fed (and the BSP) present a challenge on implementing inflation targeting. A single mandate for price stability reduces political pressure on the central bank more so, like with Germany and New Zealand, where output, employment and growth are assigned as the responsibility of fiscal, i.e. political authorities.

Doing some forensic work as an outsider based on whatever public information can be inputted in Bernanke intermediate variable columns in the matrix above (the middle four columns in the matrix), I surmise that increasing employment is not linked to GDP growth in the BSP model – growth for the GDP is all macro.

The Bangko Sentral seems to have preempted itself from using a strengthening Peso:US dollar rate for controlling inflation due to expected political pressure from OFWs, exporters, and export labor services (BPO) lobbies.

And while they raised rates and reserve requirements from August, these effort did not seem enough to stop inflation.  I think they thought base effects would help but did not.

John B Taylor on Monetary policy rules (1999 NBER). Click image to enlarge.

Monetary policy rules. Professor John Taylor of Stanford was a Governor of the Fed during the Bush 43 years.  He is noted for his research in monetary policy rules from 1993 to this book at right.  (Note: I read his 1993 paper on Rules vs. Discretion and his Chapter 7 -  A historical analysis of monetary policy rules.)

Professor Taylor showed that an algebraic relationship – with clear curve fits – between short-term interest and intermediate variables like inflation and growth adjusted for variance with expected interest and economic potential explained fully Americas short-term interest historical curve.

This algebraic relationship represents “rules” in the rules vs. discretion – an idealized dichotomy – debate on how to manage monetary policy and central banking.

Rational expectations, implemented via transparency practices, also plays a key role in his conclusion that policy rules is the better way to run central banking.

While most central banks do not use the ideal form of policy rules as the prescriptive method, they have become more transparent from th oracular Alan Greenspan years.

I used the variables of his monetary policy rule to also gather available forensic data from published report in the four rightmost columns above.

It seems to me that – especially with the run up of inflation in the past two months – the BSP either does not implement a policy rule on inflation targeting: (a) the BSP assigns a low factor for the difference between desired inflation and capacity utilization or (b) does not consider employment as a measure of GDP growth at all. Unfortunately, I can only not disprove anything from the available data.

Conclusions. Looking through the lens of Bernanke and Taylor, it seems to me that the BSP is not implementing anything in its model that defines growth in terms of increasing employment.

Then, the BSP could well treat a small country like the Philippines with a chronic case of unemployment differently, i.e. disregard under-capacity utilization, from the American technocrats’ books above based on a developed country then with full capacity utilization (+ friction unemployment).

And so, despite heralding the implementation of inflation targeting (but without the complementary program of transparency), technocrats in our BSP are really using traditional macroeconomic tools like money growth rates (from M Friedman) including measured responses to large foreign currency inflows into peso quantities.

As Asst Gov Cyd Amador said in 2007 with Dutch disease symptoms confirmed, the BSP policies had failed to preserve local manufacturing,  It is even now hard put with traditional tools, a total government strategy realignment, and without the equity infusion to help export labor services that – as mere labor cost arbitrage – are analogs to the export manufacturing of the 1970s.

Final Words for the technocrats

From the conclusions above, I still have issues with policy implementation by the BSP and will continue my meager efforts at BSP Watch. This effort is archived in SYNTHESiST under Innovator Peso. The goal of the Watch is an advocacy for a more stable peso that can facilitate long-term innovation and entrepreneurship. In this effort I do have the passion and some expertise that can be supplemented with research.

The government and the BSP have successfully moved to minimize legacy issues like public deficit and public debt (the two leftmost columns in the matrix above). 

Our sovereign credit rating by Moody’s at BA2 has vastly improved as of July 2011 though is still technically junk.  Yet, our 10-year T-bond today at 5.9% says where better than some fallen sovereigns in Europe like Spain (6.7%), Italy (7.3%) and Greece (29.9%).

A lot more effort, by politically-supported technocrats, are needed to reach into the micro-foundations to create positive reforms that will create rather than just open doors for growth.