Monetary and fiscal policy response and recent developments

Recent Developments on
Banking Industry: Impact on
Monetary & Fiscal Policy
Claro G. Ganac
1
PAMANTASAN NG LUNGSOD NG MAYNILA

2
PRESENTATION OUTLINE
I.Role of Government Policy
A. Macro-Economic Goals
B.Monetary Policy
C. Fiscal Policy
II.Recent Developments
A. Global
B. Domestic
III.Current Monetary and Fiscal Policy
IV.Conclusion

IInnttrroodduuccttiioonn
3
 The Philippines has historically been affected by global and
domestic developments that have caused the economy to
experience downturns and crisis situations.
 In the last 20 years, the country has suffered from:
 the 1997 Asian financial contagion,
 the dot.com stock market crash in the US
 corporate and financial scandals that saw the collapse of
Enron, Worldcom and Arthur Anderson accounting firm
 the 2008 US subprime mortgage credit collapse that
necessitated billions in dollars in bail-out packages
 Quantitative Easing initiatives

IInnttrroodduuccttiioonn
4
 The US financial crisis escalated into a global economic
recession that gripped most of Europe and other parts
of the world from 2008-2002.
 The Philippines was only marginally affected by the
global crisis.
 Banking reforms are now yielding fruit, particularly in
terms of better risk management and consolidated
supervision.
 This paper is an exposition of the recent developments
in the financial and banking sphere that have shaped
the way official monetary and fiscal policies in the last
decade.

GGoovveerrnnmmeenntt
aanndd FFiissccaall aanndd
MMoonneettaarryy PPoolliiccyy
5

The Role of Government
 The Philippines has traditionally had a private enterprise
economy both in policy and in practice.
 The Government undertakes socio-economic planning
toward:
 Creating and fostering economic institutions (such as
business, banks, services, etc.)
 Promoting economic progress and domestic industries
 Providing basic infrastructure
 Ensuring peace and order
 Implementing social services and fostering employment.

MMaaccrroo--EEccoonnoommiicc GGooaallss
7
 Robust and broad-based economic growth
 High employment
 Low and stable inflation
 Strong external payments position
 Sound and stable banking system
 Improved budgetary and fiscal performance

 A key role of
government is to
manage and
stabilize economic
cycles particularly
in times of
recession.
Recession
Expansion
• Economic
Output (GNP)
• Incomes
• Employment
• Prices

 The economic policies used by the government to smooth
out the extreme swings of the business cycle are called
counter-cyclical or stabilization policies.
 This was based on the macroeconomic theory of John
Maynard Keynes in the wake of the 1936 Great
Depression.
 Keynes argued that the business cycle was due to extreme
swings in the total demand for goods and services. The
total demand in an economy from households, business,
and government is called aggregate demand.
 Counter-cyclical policy involves increasing aggregate
demand in recessions and decreasing aggregate demand
in overheated expansions.

 In connection with
developing sound market-based
economic system
and liberal and increased
trade and commerce, it
establishes policies in the
fiscal and monetary
realm to accomplish
macroeconomic targets
and goals.
 It also uses fiscal and
monetary policy to regulate
economic cycles

FFiissccaall PPoolliiccyy aanndd AAggggrreeggaattee
DDeemmaanndd
 Discretionary fiscal policy refers to the
deliberate and discretionary manipulation of taxes
and government spending to alter real domestic
output and employment, control inflation, and
stimulate economic growth.
 “Discretionary” means the changes are at the
option of the government.

Fiscal Policy Choices
Expansionary fiscal
policy: used to combat
a recession.
Contractionary fiscal
policy: used to combat
demand-pull inflation,
excessive consumer
spending and bank
lending.
Income,
employment are
down
Inflation is up,
property values
too expensive,
economy is
overheated.
AGGREGATE
DEMAND

Fiscal Policy
 Fiscal policy refers to management of the levels and
changes in the taxing and spending of the national
government.
 Management of these two variables alters the level of
aggregate demand (AD) and aggregate supply (AS)
Taxes Expenditures Budget
Expansionary
Policy
Tax rates Spending,
Transfers
SURPLUS
Contractionary
Policy
Tax rates,
Collection
Spending,
Transfers
DEFICIT

EExxppaannssiioonnaarryy FFiissccaall PPoolliiccyy
Expansionary Policy needed: a decline in investment
has decreased AD, so real GDP has fallen, and also
employment has declined. Possible fiscal solutions :
a. An increase in government spending, which shifts
AD to the right by more than the change in G, due to
the multiplier.
b. A decrease in taxes (raises income, and
consumption rises by MPC times the change in
income). AD shifts to the right by a multiple of the
change in consumption.
c. A combination of increased G spending and
reduced taxes.
d. If the budget was initially balanced, expansionary
fiscal policy creates a budget deficit.

CCoonnttrraaccttiioonnaarryy FFiissccaall PPoolliiccyy
Contractionary policy: when demand-pull inflation
occurs, a shift of AD to the right in the vertical range of
AS, then contractionary policy is the remedy.
A. A decrease in G spending shifts AD back left, once the
multiplier process is complete. Here price level returns to
its pre-inflationary level, but GDP remains at full-employment
level.
B. An increase in taxes will reduce income, and then
consumption at first by the MPC times the decrease in
income, and then the multiplier process leads AD to shift
leftward still further.
C. A combined G spending decrease and tax increase
could have the same effect with the right combination.
D. If the budget was initially balanced, a contractionary
fiscal policy creates a budget surplus.

Financing Budget Deficits
 Borrowing: (“Crowding out” effect)
The government competes with private
borrowers for funds, and could drive up
interest rates; the government may
“crowd out” private borrowing, and this
offsets the economic expansion.
 Money Creation: When the BSP loans
directly to the government by buying
bonds, the expansionary effect is greater.

MMOONNEETTAARRYY
PPOOLLIICCYY

MMOONNEETTAARRYY PPOOLLIICCYY
Monetary policy is defined as discretionary acts and
directions undertaken by the monetary authorities or
the government designed to influence:
the supply of money
the cost of money (or rate of interest) of the
availability of money
For achieving specific macroeconomic objectives.

Objectives of Monetary Policy
 Price Stability
 Economic Output and Employment
 Financial Stability
 Adequate Supply Of Credit For
Growth
 Control Aggregate Demand

MMOONNEETTAARRYY PPOOLLIICCYY
 It is formulated and executed by Central Bank
(Monetary Board and the Bangko Sentral ng Pilipinas).
 It refers to set of policy instruments by which the
monetary authority controls:
• Supply of money (M1, M2 and M3)
• Reserve and liquidity requirements (for banks)
• Cost of money (or interest) through rediscounting
window and lending operations
• Foreign exchange pegs/trading to control FX within
target range (that supports both exports and
imports)

Effect of Money Supply on Aggregate
Demand and Supply
P
Q
M1 M2
}Inflation

MMoonneettaarryy PPoolliiccyy
CChhooiicceess
23
Money Supply Interest Rate Condition
Expansionary
Policy
Increase Decrease Easy Money
Contractionary
Policy
Decrease Increase Tight Money
Effects Aggregate
Demand;
Inflation
(consumer
spending)
Aggregate
Supply; Costs
of Doing
Business
(production)

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24

 Philippine economic growth accelerated to 7.2 percent in
2013 despite Typhoon Haiyan (Yolanda) and other natural
disasters. The country’s strong macroeconomic fundamentals
shielded the economy from the weak global economy.
 In 2013, Philippine financial markets experienced large
volatilities as investors responded to the tapering of the US
stimulus program. Stock and bond prices fell significantly in
June, August and December 2013.
 The outflow of portfolio investment contributed to the peso’s
12-percent nominal depreciation by year end.
 However, confidence remained high and was recognized with
a third credit rating upgrade to investment grade by
international agencies (S&P, Moodys and Fitch).
25
Domestic DDeevveellooppmmeennttss

 Monetary and fiscal policy remained supportive of growth.
With CPI inflation easing to 3 percent in 2013, policy rates
stayed at low levels of 3.5 and 5.5 percent for the overnight
borrowing and lending rates respectively.
 Government finances continued to improve with better tax
administration and efficient spending. Revenue collection
grew by about 12 percent.
 The banking sector has improved its rating levels to positive.
 Standard & Poor’s said that the banking sector remained
strong and will grow on the whole with improved performance
in balance sheet and assets, as well as profitability.
26

 The International Monetary Fund (IMF), meanwhile, expected
a monetary tightening cycle this year.
 The IMF earlier scaled back its growth forecast for the
Philippines to only 6 percent in terms of local output or the
gross domestic product (GDP) this year.
 The effect of further monetary policy tightening is not
anticipated to affect current baseline forecast due to the
pickup in fiscal spending and improvements in the external
environment.
 The BSP is expected to adoption more restrictive monetary
measures to address the growing threat of inflation.
27

 In the past three Monetary Board meetings, the MB adopted
a series of tightening moves that avoided a hike in interest
rates but had the desired effect of moderating the buildup of
price pressures.
 So far, the reserve requirement ratio (RRR) of banks has
been raised by 2 percentage points.
 The BSP also raised the interest rate on its special deposits
accounts (SDA) window by 25 basis points.
 All these were designed to tame fairly high liquidity growth
already averaging 28.4 percent in April.
28

29
 The BSP effectively accelerates the implementation of
the Basel 3 accord for universal and commercial banks,
including their subsidiary banks and quasi-banks.
A highlight of Basel 3 is the higher proportion of bank
capital that is represented by common equity.
Under the BSP framework, Common Equity Tier 1
(CET1) ratio will be set at a regulatory minimum of six
percent while the total Tier 1 ratio will be at a 7.5
percent minimum. This is on top of the current 10
percent capital adequacy ratio (CAR) requirement.
Both ratios are higher than the respective minimum
under Basel 3.

30
According to the MB, the earlier implementation of
Basel 3 would put the Philippines alongside such
jurisdictions as China, Australia, Hong Kong and
Singapore.
Basel 3 is designed to improve the ability of bank capital
to absorb losses, extend the coverage of financial risks
and have stronger firewalls against periods of stress.
 The staggered implementation of Basel 3 stretching
through the end of 2018 to allow internationally-active
banks time to raise capital organically.

31
 Banks have realigned their investment portfolio with the gradual
phase out of the BSP’s special deposit accounts (SDAs) that
started in 2013.
 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.
 Under BSP Memorandum 2013-021, trust departments were
mandated to remove 30 percent of singular investment
management accounts (IMA) parked on the SDA by July 31. A
complete phase-out was carried out in November.
 The trust departments of all banks will have to rechannel its
funds and that of clients to time deposit and lending.

 The Asian financial crisis gripped much of East Asia in July
1997 and almost led to an economic meltdown in the region.
 As the crisis spread, most of Southeast Asia and Japan saw
slumping currencies, devalued stock markets and other asset
prices, and a precipitous rise in private debt.
 Foreign debt-to-GDP ratios rose from 100% to 167% in the four
large Association of Southeast Asian Nations (ASEAN)
economies in 1993–96, then shot up beyond 180% during the
worst of the crisis.
 Economist Paul Krugman argued that East Asia's economic
growth was the result of increasing the level of portfolio
investment (also called hot money).
 In recent years, financial turbulence and insolvency have
become a major reason for economic recessions and
downturns.
32
GGlloobbaall DDeevveellooppmmeennttss

 The 2008 credit crisis in the US is a landmark event that is
the precursor to more regulation and prudential supervision
of the banking sector around the world.
 It saw the collapse of mortgage financing companies Fannie
Mae and Freddie Mac and underwriting brokers Bear Sterns
and Lehman Brothers, and the near bankruptcy of
insurer American International Group.
 The International Monetary Fund blamed the financial crisis
of 2008 on 'regulatory failure to guard against excessive risk-taking
in the financial system, especially in the US.’
33

 In addition, fraud and investment malpractices have played a role
in the collapse of some institutions, which attracted depositors with
misleading claims about returns and yields.
 Examples include the the accounting scandals perpetuated by
Arthur Anderson in the US in collusion with Enron and the collapse
of Madoff Investment Securities in 2008. At one time, Lehman’s
leveraging consisted of 30 times its equity assets.
 Maintaining stricter supervisory and regulatory regimes for the
financial system in general and banks in particular is believed to be
a safeguard to such market risks of over-leveraging, fraud and
malpractices.
 These have converged to changes in the regulation of financial
institutions and banks, particularly the Basel Accord.
34

 In the US, as a response to the prolonged US recession in
2008, the Federal Reserve (US Central Bank) implemented
the monetary intervention known as Quantitative Easing
(QE).
 QE is an unconventional monetary policy used by central
banks to stimulate the economy when standard monetary
policy has become ineffective.
 A central bank enacts quantitative easing by purchasing —
without reference to the interest rate—a set quantity of
bonds or other financial assets on financial markets from
private financial institutions.
35

36

 The goal of this policy is to increase the money supply rather
than to decrease the interest rate, which cannot be
decreased further.
 The first round of easing called QE1 was initiated in
November 2008, 3 months after the Lehman Brothers
collapse. The round lasted for 17 months, and was
considered a success. Each month, the Fed spent $100
billion to purchase mortgage backed securities (total MBS
holdings $1.7 trillion)
 The economy also appeared to have strengthened from
supported credit markets and liquidity provided to the private
sector.
37

 The Fed began the second round (dubbed QE2) from
November 2010 to June 2011. Distinct from QE1, this was to
stimulate economic activity.
 Lasting 7 months, the Fed purchased US treasuries by
spending $85 billion each month in the purchase of long
term Treasury bonds.
 This resulted in more reserve deposits (currency) flowing to
and the unloading of Treasuries in the private sector. QE2
had the effect of increasing business credit and increasing
asset prices.
38

39

 QE3: This round of QE launched an open ended MBS purchasing
program, which started at $40 billion a month and expanded to $85
billion monthly.
 The federal funds were made available at interest rate near 0.
This was a stimulus program that relieved commercial housing
market of its huge debt risk, thus easing credit markets even
further.
 On the whole, the QE interventions freed money into the financial
system which was meant to stimulate and expand bank lending
and consumer spending.
 The implication is more important: It spurred the US stock
market and aided in its recovery, as well as freed liquidity for
banks and other investors to invest in portfolio funds that
were channeled to emerging markets, including the
Philippines.
40

41

42

PPoolliiccyy RReessppoonnssee
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DDoommeessttiicc
DDeevveellooppmmeennttss
43

Monetar yy PPoolliiccyy RReessppoonnssee
 The Philippine banking system has remained resilient despite the
heightened global financial uncertainty and financial shocks.
 The BSP has been successful in using its regulatory clout to
manage the banking system and the macroeconomic and
monetary policy variables.
 Through policy instruments and moral suasion, it has strengthened
the banking sector:
 strong bank balance sheets with a return to profitability;
 improvements in risk and liquidity management;
 moves by banks into more profitable domestic business lines
such as consumer lending.
44

Current Thrusts of the BSP on
Monetar y Policies
 Managing capital flow surges
(“hot money”)
 Ensuring financial stability
 Going the distance with
structural reforms
45

 The prudential measures put in place after the Asian crisis
also included:
 instituting greater corporate governance and transparency,
 upgrading risk management standards and
 curbing excessive risk-taking of domestic banks.
 These also cover strengthening banking institutions by
cleaning up non-performing assets and increasing bank
capitalisation through Basel 2 and 3 to create a buffer during
external shocks
46

 The BSP pursued policies that continued to infuse
appropriate levels of liquidity to maintain the efficient
functioning of the financial markets and help avert the
shrinkage of domestic markets while keeping its eye on price
developments.
 It has strengthened supervisory and regulatory systems and
stricter prudential regulation of banks and quasi-banks.
 The objective is to create a steadily growing, adequately
capitalised, globally competitive significantly stronger
Philippine banking system.
47

Monetar yy SSeeccttoorr RReeffoorrmmss
 Continuing banking reform measures were worked out within the legislative
framework through the General Banking Law (GBL) of 2000 or R.A. No.
8791.
 The law gives the BSP flexibility in supervising the banking industry and
has upgraded banking laws to meet global standards, including powers
and scope of authorities of banks, outsourcing of banking functions,
foreign stockholdings, and microfinancing loans.
 The reforms will be complemented by the proposed amendments to the
Charter of the Bangko Sentral.
 The amendments will reinforce the autonomy, authority and capacity of the
BSP not only to regulate and supervise the banking system but also to
more effectively implement monetary policy.
48

Monetar yy SSeeccttoorr RReeffoorrmmss
A specific amendment to the New Central Bank Act will among others relax
existing barriers to the fight against money laundering to eliminate fraud and
the unauthorized entry of foreign money that will disrupt money and liquidity
levels in the local financial system.
The BSP also seeks to give banks and regulators the right to examine FCDU
accounts under certain conditions.
The BSP is also encouraging the restructuring of the local banking industry. In
anticipating of ASEAN 2015 integration, domestic banks need to mobilize
sufficient capitalization and to strengthen risk management systems to
compete in a more challenging and globally integrated banking environment.
This strengthening can be assisted through mergers and acquisitions and
through greater participation of foreign financial institutions.
49

Fiscal PPoolliiccyy RReessppoonnssee
In the Philippines, fiscal policy is characterized by continuous and
increasing levels of government expenditures and budget deficits.
During the Marcos era, pet infrastructure budgets, government
corporations and budget deficits were funded mainly by loans.
The first Aquino administration inherited a large fiscal deficit from the
previous administration, but managed to reduce fiscal imbalance and
improve tax collection through the introduction of the 1986 Tax Reform
Program and the value added tax.
The Ramos administration experienced budget surpluses due to
substantial gains from the privatization program involving the sale of
government assets and strong foreign investment in its early years.
50

However, the implementation of the 1997 Comprehensive Tax Reform
Program and the Asian financial crisis resulted in a negative fiscal
position in the succeeding administrations.
The Estrada administration faced a large fiscal deficit due to the
decrease in tax effort and the repayment of the Ramos administration’s
debt to contractors due to the implementation of the fast-track power
plant projects.
During the Arroyo administration, the Expanded Value Added Tax Law
was enacted, national debt-to-GDP ratio peaked, and underspending
on public infrastructure and other capital expenditures was observed.
51

This enabled the country to experience, after a long time, budgetary
surpluses. This enabled the Arroyo government to resume and expand
public infrastructure programs in 2007 up to the end of its term in 2010.
The robust infrastructure spending fueled the rise in GNP to over 7
percent in 2010.
During the early tenure of Philippine President Benigno Aquino, most
development projects were shelved or deferred, which resulted in an
anemic 3% GDP growth rate of the country in 2011.
In response, he instituted fiscal stimulus package consisting of cash
transfers (called Conditional Cash Transfer program) to boost the weak
economy and stagnant consumer spending.
52

The government had a budget surplus in 2011 due to deferrals in
infrastructure spending. This policy contributed to the decline in GNP
during the year (3% in 2011) from 7.3 percent in 2010.
The Aquino administration’s fiscal policy revolves around it proactive
liability management agenda. This meant more prudence and control
in government borrowing.
As of end-2013, the country’s general government (GG) debt to GDP
ratio improved by 1.4 percentage points (ppt) from the previous year
and 0.5 ppt from the previous quarter to reach 39.2%.
53

The country’s debt stock also continued on its healthy downward
trend. As of December 2013, the country’s Outstanding Public Sector
Debt (OPSD) was recorded at P7.65 trillion, or 66.3%of the country’s
gross domestic product (GDP).
The ratio decreased by 4.6 percentage points (ppt) from 70.9%, which
was recorded during the same period in 2012.
One of the centerpiece programs of the Aquino administration has
been the public-private partnership projects (PPPs).
Aquino recently reported the approval of 7 PPP projects which he
stressed represent key infrastructure that is needed for the Philippine
economy.
56

The 7 PPPs are worth about P62.6 billion ($1.44 billion),
notably:
Daang Hari-South Luzon Expressway Link - P2 billion ($46.11
million);
Philippine Orthopedic Center modernization - P5.98 billion
($137.88 million);
Ninoy Aquino International Airport Expressway - P15.52 billion
($357.85 million);
Automated Fare Collection System (AFCS) for the MRT/LRT
systems - P1.72 billion ($39.66 million);
Mactan-Cebu International Airport Expansion - P17.5 billion
($403.58 million). 57

Summar y of Monetar y & Fiscal
Policy
59
Fiscal Policy Monetary Policy
Definition
Fiscal policy is the use of
government expenditure and
revenue collection to influence the
economy.
Monetary policy is the process by which
the monetary authority controls the supply
of money, often targeting a rate of interest
to attain a set of objectives oriented
towards the growth and stability of the
economy.
Principle
Manipulating the level of aggregate
demand in the economy to achieve
economic objectives of price
stability, full employment, and
economic growth.
Manipulating the supply of money to
influence outcomes like economic growth,
inflation, exchange rates with other
currencies and unemployment.
Policy-maker Executive Branch and Congress Central Bank
Policy Tools Taxes; amount of government
spending
Interest rates; reserve requirements;
currency peg; discount window;
quantitative easing; open market
operations; signalling

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