Yellow Pad

Nesting Espenilla is a low-key Governor of the Bangko Sentral ng Pilipinas (BSP). He avoids the limelight, and that’s the way it should be for the head of an independent, non-political Central Bank.

But unavoidably, he becomes headline news, especially during uncertain times when prices and the exchange rate are the issues of the day.

As BSP Governor, he is principally responsible for keeping prices stable but at the same enabling a macroeconomic environment that encourages growth, investments, and jobs. This is a delicate task. As students of economics know, a trade-off occurs in the short run between growth and investments on the one hand and inflation on the other hand.

A central banker, by tradition, has to exercise prudence and hence tends to be conservative. Governor Espenilla acknowledges his conservatism. But this does not suggest at all that he lacks boldness. In the age of the black swan, when extreme outliers emerge, causing great impact for better or for worse, the qualities of being both cautious and bold are essential.

This combination of being conservative and being boldly unconventional has led to a BSP regime that many analysts have not fully appreciated. For Espenilla’s BSP, depreciation is no longer a dirty word. Inflation targeting is no longer sacrosanct. Dogma is out, context matters.

Give credit to the BSP and its leadership for being a significant contributor to the current growth momentum.

The noticeable turnaround happened in 2012. Growth rates since then have exceeded six percent. In the past decades, from the post-dictatorship late 1980s till Gloria Arroyo’s term in the 2000s, the economy could hardly sustain over time a growth rate of six percent and above. The term “boom and bust” describes our economy then.

To be sure, several factors explain the current uninterrupted high growth rates. These include the widening of the fiscal space, thanks to the 2012 sin tax reform; the awakening of animal spirits and the resultant revival of manufacturing; and the improvement in governance during the term of Noynoy Aquino.

But let’s not forget that investor confidence and economic performance are also deeply influenced by interest rates, exchange rate, and prices. It was during the governorship of Amando Tetangco, Jr., with able support from his Deputy Governors, Espenilla and Diwa Guinigundo, that the BSP charted a new path of advocating a competitive exchange rate and a monetary policy that is most responsive to growth.

(It is amazing that different political administrations have respected the independence of the BSP by making meritocracy and technocracy the criteria for governorship. Gloria Arroyo appointed Tetangco as BSP Governor. Noynoy Aquino reappointed him. After Tetangco’s two terms, Rodrigo Duterte appointed Espenilla the BSP Governor. It was a surprising appointment, considering that Espenilla is not linked to the Duterte camp and is in fact a high school pal of Aquino. But this shows how the institution based on meritocracy has endured.)

Before Tetangco’s and Espenilla’s terms, the BSP had a bias for a strong currency and low inflation, but which undermined the real sector of the economy. In truth, the currency overvaluation, inter alia, explained the episodes of economic crisis we went through.

A strong currency leading to overvaluation is worrisome during times of growth. Growth begets capital inflow, which overvalues the peso. In turn, overvaluation hurts Philippine exports and Philippine-made goods that compete with cheapened imports.

For years, the currency overvaluation was an economic binding constraint. The BSP, then under Tetangco and now under Espenilla, has addressed this binding constraint. The economy was likewise fortunate to have benign inflation for several years. The threat of overvaluation nevertheless remains, despite the peso’s depreciation.

The BSP’s policy stance has succeeded in stemming further appreciation and enabling growth that shows signs of structural transformation.

The current depreciation of the peso and the rise in inflation rate have led some quarters to criticize the economic managers, including Governor Espenilla. One perception is that the Philippine peso is one of the worst currency performers. But regardless of the drivers of the exchange rate — US interest rates, flight of hot money, the current account deficit, investor uncertainty, among others — the fact is that the nominal rate has to be aligned to the real rate. In short, depreciation is the direction.

This is a basic rule in economics — the alignment of the nominal and real prices to avoid distortions. To illustrate, the nominal wage should be consistent with the real wage; hence the regular wage adjustments. The fixed excise tax rates on fuel and other goods are also adjusted to maintain their real value.

Incidentally, with respect to the exchange rate, a distortion leaning towards devaluation or undervaluation can be beneficial for emerging economies to gain greater competitiveness.

We have calculated the real effective exchange rate, and depending on the choice of the base year, we find that the nominal and real rates are more or less aligned. The worse case is the peso still being slightly overvalued. In other words, the BSP’s policy preference is to allow some depreciation. Without depreciation, the peso would have been stronger, but that would have been bad for exports and import substitutes (and to jobs and incomes of families of overseas Filipino workers).

Some analysts have likewise criticized BSP for being reactive in combating inflation. They say that the BSP should have raised interest rates much earlier. The problem with this is that a rise in interest rates is an inappropriate instrument to tame supply-side inflation. How can increasing interest rates address the rice shortage or increasing world prices of crude oil? The BSP eventually hiked interest rates to manage inflation expectations.

Parenthetically, critics have blamed the economic managers for the rise in inflation. They describe present inflation as runaway, galloping, or soaring. Do read the literature on inflation and growth (R. Dornbusch and S. Fischer, 1991 and M. Bruno and W. Easterly, 1995) to understand why these critics are mistaken.

The economic managers are responsible for the comprehensive tax reform also known as TRAIN, which has contributed to inflation. But a breakdown of the causes of inflation shows that the TRAIN’s contribution to inflation is minimal. Separate estimations of the BSP, Department of Finance, and nongovernment entities like Action for Economic Reforms uphold this view.

A hard reform like TRAIN is a necessary condition for sustaining growth and making growth inclusive. It is long overdue. A lesson from contemporary economic history is to do critical reforms when growth is good.

We continue to have high growth. In fact, economic performance could have been better if not for the problems created by President Duterte. For example, the spike in the price of rice is the fault of no less than President Duterte for siding with the narrow protectionist rice policy of the Department of Agriculture and National Food Authority. In other instances, Duterte ignored the advice of the economic managers, and encouraged populist but fiscally irresponsible measures.

Amid the complex if not volatile political and economic situation, we need the qualities of technocrat reformers like Governor Espenilla. Fiercely independent, conservative at the same time unconventional, astute in economics and political economy, and honorable.

(Governor Espenilla, who is on extended medical leave, celebrated his 60th birthday on Oct. 12.)


Filomeno S. Sta. Ana III coordinates the Action for Economic Reforms.