The Last Thing We Need Is Another “Interest Cure” Episode

We express our most vigorous opposition to the return of the “interest rate cure” to address the economic turmoil besetting thecountry in the aftermath of the explosion of the jueteng scandal.

Recently, the Bangko Sentral ng Pilipinas (BSP) increased reserve requirements and jacked up its overnight borrowing rate by four percent. As an immediate result, prime lending rates have sharply increased, with some banks even charging prime rates above 20 percent. Worse, the BSP is contemplating a higher increase in interest rates to insulate the peso from further attacks. There is a persistent report that the BSP favors the issuance of T-bills with an interest yield of up to 40 percent, similar to the one issued by Central Bank governor Jobo Fernandez in 1984 (hence, the term Jobo bills). If this policy is pushed through, then the nascent, fragile economic recovery
we are nurturing is doomed. This arguably will be, to borrow a new idiom coined by an Estrada adviser, “the pin (sic) that broke the camel’s back.”

Painful Lessons

Let us go back to history. The interest cure in the 1980s indeed brought down inflation and stabilized the exchange rate. The desired direction of prices and currency valuation was achieved in very effective fashion. But this was at the expense of the real economy, which shrunk! In the end, the winners were not the people but the “hot money” investors as well as moneyed financial institutions. The poor–as always, the ones who suffer the most–had to bear the brunt of a severe output contraction. Consider some data.

Table 1: Previous Episodes of Interest Rate Cure

Year Interest Rate
(in %)
GDP Growth
(in %)
Exchange Rate
1985 24.80 (TB 91) -7.31 22.5-18.5
1991 32.15 (TB 91) -0.50 27.5-25.5
1992 16.12 (TB 91) 0.93 27.5-25.5
12 mo. ave. December (high)
1997 13.1 (TB 91) 5.20 29.4707 37.1706

Table 1 shows that in 1985, based on the 91-day T-bill, the interest rate went up to 24.8 percent. This brought about the peso appreciation from 22.5 to 18.5 pesos to a dollar. Stabilization of prices and exchange rates was traded off for a deep GDP plunge of 7.31 percent! In 1991, the interest rate jumped to 32.15 percent, which brought about a two-peso appreciation and a recession.
Interest rate was still high in 1992 to back up a strong peso, leading to a measly 0.93 percent real sector growth.

When the Asian financial crisis struck in 1997, the BSP’s initial response was to hike interest rates. This however did not prevent the peso from further devaluing even as it brought bigger damage to the economy. Fortunately, the policy was soon reversed in light of public pressure: The direction toward a low interest policy and away from, for instance, floating high-interest T-bills, enabled the economy to avoid a bigger crisis.

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