BSP's Reserve Requirement Ratio Cut Is Undeniably Very Procyclical at the Top of the Business Cycle

On February 15, 2018, the BSP said that it would lower bank's reserve requirement ratio from 20% to 19%, a move that is projected to inject at least Php 80 billion (US$ 1.53 billion) into the financial system.

This move was ostensibly done to mitigate the effects of global market volatility in the first two weeks of February 2018. But it is easy to get the impression that BSP panicked because the announcement was a surprise and was made after an unscheduled policy meeting.

This move is also undeniably pro-cyclical, coming near the top of the business cycle:

"Such an infusion of funds would risk adding to inflationary pressures in the booming economy. Some market watchers fear it is already at risk of overheating..."

It will also serve to boost asset inflation even further. Philippine interest rates are already negative as it is and have been for some time. Since 2010, anyone investing in Philippine T-Bills would have seen negative to marginal real returns after accounting for inflation. As of January 2018, the real interest rate on the 364 day T-Bill was a negative 1.12%. Increasing the money multiplier by 5.3% will only serve to lower negative real interest rates even further - at least in the short run.

 To boost real returns, investors will have to pile into physical and financial assets which are already at record high prices.

To wit, the Philippine Stock Market is already at or near record highs:

 And so is the real estate market:

 It is no coincidence that the greatest increases in asset inflation took place at a time when real interest rates were profoundly negative - as much as 2.3% during a four year period from 2011 to 2014 and in the last two years (beginning in 2016 to present).

To seek yield, investors will have to pile into even more economically marginal investments. When the business cycle turns, as it always does, expect the NPLs to pile up and put our banking system and the Philippine economy on the brink of collapse once again. A pro-cyclical macro policy taking place at the top of the business cycle will only make the bottom of the cycle that much worse. Policy makers should consider macro policies that moderate the top of the economic cycle: counter-cyclical at the top and pro-cyclical at the bottoms. In this way, the tops are less overheated and the bottoms are not as traumatic for the economy as a whole.