BSP MONETARY POLICIES

MONETARY POLICIES • measures or actions taken by the central bank

to regulate money supply in the economy• aimed at influencing the timing, cost and

availability of money and credit as well as other financial factors, for the purpose of stabilizing the price level

BSP specifically adopted a low and stable inflation rate as the ultimate target of monetary policy.

Expansionary Monetary Policy – monetary policy setting that intends to increase the level of liquidity/money supply in the economy and which could also result in a relatively higher inflation path for the economy. Examples are the lowering of policy interest rates and the reduction in reserve requirements. Expansionary monetary policy tends to encourage economic activity as more funds are made available for lending by banks. This, in turn, increases aggregate demand which could eventually fuel inflation pressures in the domestic economy.

Contractionary Monetary Policy - monetary policy setting that intends to decrease the level of liquidity/money supply in the economy and which could also result in a relatively lower inflation path for the economy. Examples of this are increases in policy interest rates and reserve requirements. Contractionary monetary policy tends to limit economic activity as less funds are made available for lending by banks. This, in turn, lowers aggregate demand which could eventually temper inflation pressures in the domestic economy

• INFLATION TARGETING- Adopted by BSP on January 2002- Inflation target serves as a nominal anchor, aimed at coordinating inflationary expectations- Entails the announcement of an explicit nominal inflation target which the central bank commits to achieve over a given period of time- Inflation target is set by the government and the BSP

• The government’s inflation target is defined in terms of the average year-on-year change in the consumer price index (CPI) over the calendar year.

• The inflation targets have been set at 4.5 percent with a tolerance interval of + 1.0 percentage point for 2010 and 4.0 percent with a tolerance interval of + 1.0 percentage point for 2011.

Inflation ReportThe Inflation Report is published quarterly

as part of the BSP's transparency mechanism under inflation targeting and to convey to the public the overall thinking and analysis behind the BSP's decision on monetary policy.

Open Letter to the President

To ensure accountability in cases where the BSP fails to achieve the inflation target, the BSP Governor issues an Open Letter to the President outlining the reasons why actual inflation did not fall within the target, along with the steps that will be taken to bring inflation towards the target. Open Letters to the President have been issued on 16 January 2004, 18 January 2005, 25 January 2006, 19 January 2007, 14 January 2008 and 26 January 2009.

• OPEN MARKET OPERATIONS

- Transactions involve the sale or purchase of securities by the BSP to withdraw liquidity from or inject liquidity into the system

- Key component of monetary policy implementation consist of repurchase and reverse repurchase transactions, outright transactions, and foreign exchange swaps.

A.Repurchase (RP) and Reverse Repurchase (RRP) - transactions are carried out through the repurchase (RP) facility and the reverse repurchase (RRP) facility of the BSP.

A.1 In a repurchase or repo transaction, the BSP buys government securities from a bank with a commitment to sell it back at a specified future date at a predetermined rate. The BSP’s payment to the bank increases the latter’s reserve balances and has an expansionary effect on liquidity.

A.2 In a reverse repo, the BSP acts as the seller of government securities and the bank’s payment has a contractionary effect on liquidity. A.3 RP and RRP transactions have maturities ranging from overnight as well as two weeks to one month. The interest rates for the overnight RRP and RP facilities signal the monetary policy stance and serve as the BSP’s primary monetary policy instruments.

B. Outright transactions refer to the direct purchase/sale by the BSP of its holdings of government securities from/to banking institutions. In an outright transaction, the parties do not commit to reverse the transaction in the future, creating a more permanent effect on money supply. The transactions are conducted using the BSP’s holdings of government securities. When the BSP buys securities, it pays for them by directly crediting its counterparty’s Demand Deposit Account with the BSP.

The transaction thus increases the buyer’s holdings of central bank reserves and expands the money supply.

Conversely, when the BSP sells securities, the buyer’s payment (made by direct debit against his Demand Deposit Account with the BSP) causes the money supply to contract.

C. Foreign exchange swaps refer to transactions involving the actual exchange of two currencies (principal amount only) on a specific date at a rate agreed on the deal date (the first leg), and a reverse exchange of the same two currencies at a date further in the future (the second leg) at a rate (different from the rate applied to the first leg) agreed on deal date.

• Acceptance of fixed-term depositsThe BSP also accepts deposits from banks. 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.

In April 2007, the BSP expanded access to the SDA facility by allowing trust entities to deposit in the SDA facility in order to better manage liquidity in the face of strong foreign exchange inflows.

• Standing FacilitiesC.1 The BSP extends discounts, loans and advances to banking institutions in order to influence the volume of credit in the financial system. Rediscounting is a standing credit facility provided by the BSP to help banks meet temporary liquidity needs by refinancing the loans they extend to their clients. The rediscounting facility allows a financial institution to borrow money from the BSP using promissory notes and other loan papers of its borrowers as collateral.

There are two types of rediscounting facilities available to qualified banks: the peso rediscounting facility and the Exporters’ Dollar and Yen Rediscount Facility (EDYRF) which was introduced in 1995.

• Reserve Requirements

Reserve requirements refer to the percentage of bank deposits and deposit substitute liabilities that banks must keep on hand or in deposits with the BSP and therefore may not lend. Changes in reserve requirements have a significant effect on money supply in the banking system, making them a powerful means of liquidity management.

Reserve requirements apply to peso demand, savings, time deposit and deposit substitutes (including long-term non-negotiable tax-exempt certificates of time deposit or LTNCTDs) of universal banks (UBs) and commercial banks (KBs) and may be kept in the form of cash in vault, deposits with the BSP and government securities.

Required reserves consist of two forms: regular or statutory reserves; and liquidity reserves.

Deposits maintained by banks with the BSP up to 40 percent of the regular reserve requirement are paid interest at 4 percent per annum, while liquidity reserves are paid the rate on comparable government securities less half a percentage point.

The use of liquidity reserves help to reduce bank intermediation costs since they are paid market-based interest rates.

In March 2006, the Monetary Board began to require banks to keep liquidity reserves in the form of term deposits in the reserve deposit account (RDA) with the BSP instead of government securities bought directly from the BSP.

MONETARY POLICY DECISIONS

28 January, 11 March, 22 April, 3 June, 26 August, 18 November

The Monetary Board decided to keep the BSP’s key policy interest rates steady at 4 percent for the overnight borrowing or reverse repurchase (RRP) facility and 6 percent for the overnight lending or repurchase (RP) facility. The interest rates on term RRPs, RPs, and special deposit accounts (SDAs) were also left unchanged.

• MORAL SUASIONBSP uses moral suasion to influence the behaviour of the banking system.BSP does this by holding frequent and regular dialogues with bankers and other financial market players in order to inform them of the policy actions of BSP and the reason for these actions as well as influence them to respond positively to these policy directions.