Growth with stable inflation: Beyond monitoring

Of substance and spirit

With all the volatilities in the global economy, delivering sustainable growth this year and the subsequent years should be difficult enough, but ensuring it comes with low and stable inflation would test the mettle of the three-month old administration of President Bongbong Marcos.

As it is, the President’s plate might have more than he could chew.

Just the other day, the International Monetary Fund (IMF) downgraded its economic growth forecast for the Philippines from 6.7 percent to 6.5 percent in 2022 a day after Super Typhoon Karding delivered heavy rains and strong winds to Luzon including Metro Manila. The World Bank, on the other hand, reported to have upgraded its 2022 growth forecast from 5.7 percent to 6.5 percent, the lower end of the output target.

Don’t get this column wrong; a 6.5 percent growth is more than respectable!

While the World Bank extracted its bright hope from the strong recovery of private consumption, notwithstanding the inflationary trend, the Fund chose to downgrade due to global factors particularly the potential recession in both the US and China. The US Fed’s aggressive attempt to arrest historic-high inflation could lead to some dissipation of consumer purchases and tepid investment. China’s woes derive from the pandemic lockdown and external shocks. Since the Philippines trades mostly with these two big economies, business momentum might stall.

Of course, there are equally important domestic factors that could restrain more than full recovery. Agriculture is in bad shape. Tight supply of pricey agricultural commodities like sugar and pork is moderating business activities in the downstream. Manufacturing is also reined in because it is dependent on both credit and imports. With the need for tight monetary policy, higher borrowing rates are hurting producers. With fast and furious peso depreciation, higher import costs are discouraging some domestic processing. Services face the risk of another lockdown due to possible resurgence of Covid-19.

It should not surprise us therefore that the Fund’s new growth forecast sank at the lower end of the official target of 6.5-7.5 percent for 2022 and the 2023 projection of 5.0 percent is way too short of the Philippine government’s ambitious target of 6.5-8.0 percent. We might be seeing relatively lower growth alongside higher inflation for both 2022 and 2023.

It was correct for our friend, Cheng Hoon Lim, IMF mission head, to emphasize that the country’s prognosis for growth is subject to significant downside risks including pandemic resurgence, deterioration in global financial conditions, deepening global slowdown and yes, “persistently high domestic inflation.”

That last downside risk was confirmed by no less than the BSP itself last week when it announced its 2022 inflation forecast creeping from 5.4 percent to 5.6 percent and from 4.0 percent to 4.1 percent for 2023.

This more than justifies BSP’s strategic policy to act decisively. Due to its delayed reaction to what turned out to be more than transitory inflation pressures at the beginning of the year, the BSP was set back and is now correctly catching up with more aggressive tightening, delivering in five months 225 basis points (bps) increase in its policy rate. Otherwise, if inflation persists and the BSP is forced to keep its pace of monetary tightening, higher market rates might begin to restrict credit and hurt growth.

What could also contribute to a possible failure to achieve both good economic growth and manageable inflation is the Typhoon Karding factor. Some 16,229 hectares of agricultural land in Central Luzon were devastated. The Department of Agriculture (DA) reported that among the affected crops is rice in addition to corn and high-value crops.

This recent weather challenge is expected to reverse the two-year relatively modest rice price trend in the Philippines by the last quarter of 2022. Already, the global rice supply is threatened by the potential decline in rice production in India, China, Bangladesh, and Vietnam due to weather-related factors. Worse, India might restrict exports while China is about to increase imports.

Outside of supply factors, demand components of inflation have strengthened. Core inflation has been on the rise since the beginning of the year, marking August 2022 at 4.6 percent. Upward adjustments in wages have been implemented throughout all the regions in the Philippines while higher public utility transport fares have also been cleared.

We seem to have reached that point when we are experiencing what economists call positive output gap. This is a situation when we are growing beyond our potential capacity of not more than 6.0 percent because it has been slashed by the pandemic. Our excess growth came from some temporary boosters including large ticket items in infrastructure, revenge spending in food and tourism and excessive domestic liquidity.

Some wise guys cannot therefore fault BSP for its aggressive monetary action; those who insist inflation remains a supply issue are assessing in the past.

If there is any risk in the horizon that could tame inflation but kill business is the potential resurgence of the virus. This is not a remote possibility because the Department of Health reported that last week, Covid-19 cases rose at a daily average of 2,556 infections or 22 percent over the week previous to it. No surprises here considering that mobility restrictions are now effectively lifted, mandatory use of face masks is limited, and standing is now allowed in buses and e-jeeps.

It is obvious the solution goes beyond simple monitoring of either the exchange rate or consumer prices. Aggressive monetary action should be allowed to run its course, rather than scuttle it. Taming inflation with what it costs should promote more sustainable growth in the future. Structural initiatives on the supply side including logistics should have been done yesterday but it is worth pursuing them today.