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Philippines to keep rates on hold with lenders well placed to handle COVID-19

Banks in the Philippines are in a stronger position now than during the Asian financial crisis, giving room to the nation's central bank to hold fire as it waits for previous rate cuts to work their way through the economy, Bangko Sentral ng Pilipinas Governor Benjamin Diokno said.

The COVID-19 crisis is expected to push nonperforming loans higher, but Diokno does not see bad loans as a problem yet and said the BSP prefers to adopt a wait-and-see approach to see how the cumulative 175-basis-point cut in its benchmark overnight reverse repurchase rate this year is absorbed by the financial system.

"I think I'm quite comfortable where we are right now and this will probably be where we will be in the next few quarters. So I don't see [more] cuts at the moment or in the next few quarters," Diokno said in an interview with S&P Global Market Intelligence on July 13.

The central bank reduced rates four times this year, including a 50-basis-point cut at a rare unscheduled meeting of its monetary board in April as it seeks to support an economy struggling with the coronavirus pandemic. The BSP's benchmark overnight borrowing rate has been slashed to a record low of 2.25%.

The government imposed strict lockdowns in March, though it has since lifted some restrictions with a reopening of Metro Manila from June 1. The relaxations, aimed at restarting economic activity, come amid rising unemployment. The jobless rate rose to 17.7% in the quarter ending April from 5.3% in January, according to government data.

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Strong banks

However, the central bank chief was sanguine about the strength of the Philippine banking system. The average nonperforming loans ratio was 2.31% in April and rose slightly to 2.43% in May, data from the BSP showed. During the Asian financial crisis of 1997, the NPL ratio ranged between 3.0% and 3.4% before peaking at 17.6%, Diokno said.

"I think there will be an uptick [in bad loans] but we won't know for sure until we totally open the economy. But I'm quite sure it's not going to reach the level that we reached during the Asian financial crisis," Diokno said.

Still, to mitigate any potential rise in nonperforming loans, the BSP is supporting the establishment of asset management corporations, Diokno said, pointing to a bill in Congress to allow banks to transfer their distressed assets to such reconstruction companies. The proposed new asset management companies could be government- or privately owned, Diokno said, but they will be given fiscal incentives. The bill is expected to be discussed when Congress resumes in late July.

Local banks are also well-capitalized due to the central bank's strict capital requirements. The BSP has adopted Basel III requirements in full, requiring banks to meet 10% total capital adequacy ratio with a 6% common equity Tier 1 ratio.

Nicholas Mapa, senior economist for the Philippines at ING, said while metrics show banks to be well-capitalized and NPL ratios tp be low, "I would like to note that lending to households has increased over time; a key difference between the Asian financial crisis and today." That could pose a risk if the disease outbreak hurts household incomes significantly, he said.

S&P Global Ratings said Philippine banks will likely see asset quality deteriorate amid the economic slowdown, which will weigh on profitability. However, Philippine banks "have built good financial buffers and are entering this slowdown on a relatively sound footing," according to a June 18 report. Banks' loan books are also largely built on large conglomerates, which will be able to tide over the challenging operating conditions, Ratings said.

Space to maneuver

Diokno said Philippine policymakers have a lot more fiscal and monetary space to manage the impact of the pandemic. Compared with the Asian financial crisis, when the country was running low on U.S. dollar reserves, its gross international reserves stood at US$93.3 billion as of May 2020 and are expected to climb to US$95 billion by the end of the year.

The government, too, is in a better position than some of its neighbors in dealing with the economic impact of the pandemic, said Diokno. While the Philippines is facing the same challenges in terms of the health crisis, "on the fiscal side, because of our lessons from the Asian financial crisis, we were also able to reduce the debt-to-GDP ratio to around 39.6% by the time the pandemic hit us. Compared with our peers, we can jack it up to maybe around 50% and that would still be manageable," he said.

The Philippines does not need to borrow funds from abroad yet to increase liquidity in the system as the central bank still has a lot of monetary space, the governor added. At its last meeting in June, the BSP's monetary board decided that a further reduction in the policy rate amid a benign inflation environment would help mitigate the downside risks to growth and boost market confidence. The central bank expects inflation to settle near the low end of its 2%-4% target range through 2022, with the balance of risks to the outlook leaning toward the downside.

ING's Mapa also expects the BSP to "refrain from further rate cuts in the near term as real policy rates are now negative," adding that he does not think the governor "will push real policy rates deeper into the red." Mapa forecasts inflation to average 2.5% for the year.

Ruben Carlo Asuncion, the chief economist at Union Bank of the Philippines, also expects the central bank to "park its monetary policy ride" as the benchmark interest rate at 2.25% is "already appropriate" and supported by high levels of liquidity in the market. The "aggressive monetary policy rate cuts are really commendable but [are] better complimented by corresponding fiscal policy," he said, pointing to an expected stimulus package from the government.