source.. reference electronic rediscounting system, open market operation and core inflation...

8/14/2019 source.. reference Electronic Rediscounting System, oPen Market Operation and Core Inflation (PBE).docx

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Electronic Rediscounting System

The Electronic rediscounting system or eRediscounting is an online internet-based rediscounting facility that

the BSP makes available to all active and qualified banks nationwide. This facility allows banks to conduct

their rediscounting transactions and inquiries with the BSP in an on-line, real time basis at the convenience

of their own bank premises. With its simplified and end-to-end processing capability, the system provides

immediate availability and fast delivery of credit to banks, especially those in the countryside. More

importantly, it will reduce the transaction costs of banks, which will mutually benefit the participating banks

and their clients.

Banks with established rediscounting lines may participate in the eRediscounting by complying with the

execution of all the required documents, i.e., the Electronic Rediscounting System Participation Agreement,

User Account Registration, and User Specimen Signature form. For further inquiries, please contact the

Systems Development and Management Division of DLC at Tel. Nos. 306-2807/306-2351.

The main objective of the e-Rediscounting System is the simplification, standardization, and automation of

loan processes and payment procedures. The front-end system of e-Rediscounting allows qualified banks to

conduct their rediscounting transactions with the BSP through the Internet. The back-end system

automates the processing of loan applications, crediting of loan proceeds, debiting of the demand depositaccounts of banks with BSP for loan payments and generating account entriesall in less than 10

minutes. This paperless rediscounting facility allows banks to file or send loan applications and payments

with the BSP on a real-time basis, and is a landmark improvement from the manual system which takes at

least three days to process before the loan proceeds are released to borrower-banks.

Open Market Operations

Policy Rate Setting

The Bangko Sentral ng Pilipinas (BSP) formally adopted inflation targeting as the framework for monetary

policy in January 2002. This policy move is aimed at providing the BSP with a more focused and forward-

looking approach in the pursuit of its primary mandate, which is to ensure price stability. Two intrinsicfeatures of the approachtransparency and accountability in monetary policyis expected to enhance the

credibility of the BSP in helping create a stable macroeconomic environment in which vital economic reforms

to raise the growth potentials of the economy can continue.

This approach involves the announcement of an explicit inflation target that the BSP promises to achieve

over a given time period. The target inflation rate is set and announced jointly by the BSP and the

government through an inter-agency body. Although the responsibility of achieving the target rests primarily

with the BSP, this joint announcement reflects active government participation in achieving the goal of price

stability and government ownership of the inflation target.

In the Philippines, the interest rates applied on the overnight RP/RRP signals the stance of BSPs monetary

policy. The BSP created an Advisory Committee which deliberates, discusses and recommends to the

Monetary Board the appropriate monetary policy stance that will enable the BSP to achieve the desired

inflation target. The Advisory Committee meets every six weeks and in between regular meetings, whenever

it is deemed necessary.

Policy Instruments

The BSP implements monetary policy using various instruments to influence the level of liquidity in the

market and thereby steer inflation towards thetarget level. These instruments can be classified into two

types:


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Direct instruments enable the BSP to control directly certain items in banks balance sheets which

may be in the form of financial prices or quantities. Direct instruments have a strong coercive

element as in the case of reserve requirements and directed lending requirements.

Indirect instruments work through the market to influence the behavior of financial institutions,

usually through the pricing of central bank facilities. Indirect instruments include adjustments in

short-term policy interest rates and the conduct of open market operations (OMO).

Mechanics of OMO

OMO is a monetary tool which involves the BSP publicly buying or selling government securities from banks

and financial institutions in order to expand or contract the supply of money. By controlling the money

supply, the BSP is able to exert some influence on the prices of goods and services and achieve its inflation

objectives.

When the BSP buys securities, it pays for them by directly crediting its counterpartys Demand Deposit

Account that is being maintained with the BSP. Effectively, the transaction increases the buyers level of

reserves and on an aggregate level, expands the systems money supply. Conversely, when the BSP sells

the securities, the buyers payment (via direct debit against the buyers Demand Deposit Account with theBSP) reduces his reserve account causing money supply to contract.

In conducting OMO, the BSP uses two instruments: (1) repurchase (repo)/reverse repurchase (reverse repo)

agreements and (2) outright purchases and sales of securities.

Repurchase (repo) / reverse repurchase (reverse repo) agreements.The BSP purchases

government securities from a bank with a commitment to sell it back at a specified future date at a

predetermined rate. In effect, a repo transaction expands the level of money supply as it increases

the banks level of reserves. Under a reverse repo, the BSP acts as the seller of government

securities, thus, the banks payment reduces its reserve account resulting in a contraction in the

systems money supply. For both repos, the BSP can only affect the level of money supply

temporarily, given that the parties involved commit to reverse the transaction at an agreed future

date. At present, the BSP enters into repo agreements for a minimum of one (1) day (overnight) for

both repos and a maximum of 91 days and 364 days for repo and reverse repo agreements,

respectively.

Outright purchases and sales of securities. An outright contract involves direct purchase/sale ofgovernment security by the BSP from/to the market for the purpose of increasing/decreasing moneysupply on a more permanent basis. In such a transaction, the parties do not commit to reverse thetransaction in the future, creating a more permanent effect on the banking systems level of moneysupply.

Foreign exchange swapsrefer to transactions involving the actual exchange of two currencies(principal amount only) on a specific date at a rate agreed on the deal date (the first leg), and areverse exchange of the same two currencies at a date further in the future (the second leg) at arate (different from the rate applied to the first leg) agreed on deal date.

The BSP may also use other monetary policy tools such as reserve requirements and rediscounting to

expand or contract money supply. The BSP may also grant loans and advances to banking institutions to

influence the volume of credit consistent with the objective of price stability. In addition, the BSP can

employ moral suasion as a last resort when existing market mechanisms cannot adequately and promptly

ensure the attainment of specific monetary objectives.

Advantages of Open Market Operations


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However, among the tools available to the BSP, OMO offers advantages and continues to be the most

practical tool for the following reasons:

First, it works within the BSPs initiative and control. Having the authority to steer market interest

rates, the BSP can influence money supply by changing the monetary policy rates. Consequently,

OMO gives the BSP greater flexibility in terms of the amount and timing of intervention.

Secondly, it is fast to implement and gives quick results. Any change in the policy rates is readily

implemented, i.e., on the same day that the Monetary Board makes the resolution. Thus, any effect

on the market is evident right after the overnight trading for the day.

Call Loans and the Interbank Call Loan Market

Call money are amounts traded in the interbank call loan market that correspond to the excess or deficiency

of each bank in terms of reserves. These can be overnight placements.

IBCL transactions among banks are done primarily to correct reserve requirements. The reserve position of

each bank or quasi-bank is calculated daily on the basis of the amount of the institutions reserves at the

close of business for the day and the amount of its liability accounts against which reserves are required tobe maintained. The reserve positions of banks are normally known after the check clearing results have

been transmitted. As the check clearing results are known only by late afternoon, interbank call loans are

currently done from 4:45 PM to 5:30 PM.

The interbank market can either be securitized (collateralized) or unsecuritized (clean) lendings/borrowings,

as well as repurchase agreements. Repurchase Agreements (RPs) are generally short-term sale of

government securities with an agreement to repurchase on the agreed maturity date. Repurchase

agreements are extensively used as a means of short-term financing by government securities dealers and

by banks.

Banks establish credit lines with its counterparties for these transactions.

Managing Risks in OMO Transactions

A valuation scheme for securities used in repos is adopted by the BSP to help manage the credit risk

inherent in OMO transactions. Eligible securities are valued based on their current market yields as well as

the applicable cut based on remaining life of securities involved.

To avoid exposing the BSP to undue risks arising from purchases of securities, Section 91, Article V of RA

7653 (The New Central Bank Act) sets the type of securities that can be bought or sold by the BSP for its

own domestic portfolio, as follows:

Evidences of indebtedness issued directly by the Government of the Philippines or by its political

subdivisions; and

Evidences of indebtedness issued by government instrumentalities and fully guaranteed by the

Government.

Section 92 of the same article also provides the BSP with effective instruments for OMO, that is, it may,

subject to such rules and regulations as the Monetary Board may prescribe and in accordance with the

principles stated in Section 90, issue, place, buy and sell freely negotiable evidences of indebtedness of the

BSP, provided that such issuance shall be made only in cases of extraordinary movement in price levels.

Said evidences of indebtedness may be issued directly against the international reserves of the BSP or


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against securities, which it has acquired under the provisions of Section 91 or may be issued without relation

to specific types of assets of the BSP.

OMO is an activity by a central bank to buy or sell government bonds on the open market.

A central bank uses them as the primary means of implementing monetary policy.

The usual aim of OMO is to control the short term interest rate and the supply of base money in an

economy, and thus indirectly control the total money supply.

This involves meeting the demand of base money at the target interest rate by buying and selling

government securities or other financial instruments.

Monetary targets, such as inflation, interest rates or exchange rates, are used to guide this

implementation.

On the part of the BSP, it is no longer floating own bonds since its charter was amended 19 years ago.

Deputy governor for monetary stability sector Diwa Guinigundo said the primary objective of OMOs is to

promote price stability to keep the price of commodities, particularly the basics, affordable by the local

currency.

That is inherently a governmental function. It is an operation that is necessary to deliver on our primary

mandate to promote price stability. The BSP does not engage in OMO to make money but to ensure

appropriate levels of money supply consistent with our price stability objectives, Guinigundo explained to

The Daily Tribune in an exclusive interview.

However, the BSP is not tax-free when doing OMO, especially in participating in the market to assure that

the peso will not appreciate that much against the dollar.

The tax bite is an added expense to

BSP, much more the expenses every time it buys excess dollars in the system.

Despite the losses it will surely incur from OMO, Guinigundo said the BSP is mandated to do so under its

charter.

A source who refused to be named said it would be very dreadful if the BSP stays out of the market and

let the peso appreciate much.

I cant imagine how much it would appreciate against the dollar. If that happens, all export firms will close

shop and more overseas Filipino workers will just go home as their dollar would be very weak, the source

said.


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CORE INFLATION

1. What is core inflation?

Core inflation is a widely-used measure of the underlying trend or movement in the average consumerprices. It is often used as a complementary indicator to what is known as headline or CPI inflation(see below).

2. How is core inflation different from CPI or headline inflation?

Headline inflation refers to the rate of change in the consumer price index (CPI), a measure of theaverage price of a standard basket of goods and services consumed by a typical family. In the

Philippines, this CPI is composed of various consumer items as determined by the nationwide FamilyIncome and Expenditure Survey (FIES) conducted every three years by the National Statistics Office(NSO).

Headline inflation thus aims to capture the changes in the cost of living based on the movements ofthe prices of items in the basket of commodities and services consumed by the typical Filipinohousehold.

On the other hand, core inflation measures the change in average consumer prices excluding certainitems in the CPI with volatile price movements. As such, core inflation may be viewed as a measure ofunderlying long-term inflation and as an indicator of future inflation. Core inflation is usually affectedby the amount of money in the economy, relative to production, or by monetary policy.

The graph below shows that headline inflation has been more volatile over the years while coreinflation has been more stable, and has effectively captured price trends by taking out the effects oftemporary disturbances or shocks on CPI.


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Weighted Median

New Zealand CPI excluding interest charges

SingaporeCPI excluding costs of private road

transport and costs of accommodation

CPI excluding volatile items(30%)

Weighted Median

Trimmed Mean (15%)

Structural VectorAutoregression (VAR) modelestimate

Japan CPI excluding Fresh Food

Peru

CPI excluding 9 volatile items (food, fruits

and vegetables, and urban transport,

about 21.2 %)

United

StatesCPI excluding food and energy

United

Kingdom

Retail price index excluding mortgage

interest Rates (RPIX)

Weighted median

Trimmed mean (15%)

Chile

CPI excluding 20% with higher (-)

variations and 8% with higher (+)

variations

ColombiaCPI excluding agricultural food, publicservices, and transport

Germany CPI excluding indirect taxes

SpainCPI excluding energy and unprocessed

food (IPSEBENE)

Netherlands ULI minus fruits, vegetables, and energy

Ireland

CPI (ULI 1) less mortgage interest

payments (MIPS)

CPI (ULI 2) excluding MIPS and food and

energy

PortugalCPI (ULI) less unprocessed food and

energy

7. How do policymakers use core inflation in other countries?

Most statistical agencies in other countries use core inflation as a supplementary indicator to headline

inflation and publish it alongside the headline rate. Some inflation targeting central bankssuch as thecentral banks from Canada, Czech Republic, Finland, Thailand, South Africa and South Koreausecore inflation as the operating target for the conduct of monetary policy.

8. Is there an official definition of Core Inflation in the Philippines?


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Yes. There is now an official definition of core inflation in the Philippines. The National StatisticalCoordination Board (NSCB) through NSCB Resolution No. 6 Series of 2003 has adopted an officialdefinition and methodology for computing core inflation in the Philippines based on the exclusionmethod. Thus, while headline inflation is calculated as the year-on-year change in the overall CPI

compiled by the NSO, the official core inflation measure is defined as the rate of change of headlineCPI after excluding selected food and energy items.

9. How was the official definition of core inflation determined?

The official definition is the output of inter-agency technical discussions among the NSO, the NSCB,the National Economic Development Authority (NEDA), the Statistical Research and Training Center(SRTC), the National Wage and Productivity Commission (NWPC), the Department of Trade andIndustry (DTI), and the Bangko Sentral ng Pilipinas (BSP).

10. Why was the exclusion method chosen for the official definition?

The exclusion method was chosen because: (a) it is easier to understand compared to the other

methodologies; (b) it is more transparent and can be easily computed by anyone from CPI data; (c) itcan be computed at the same time as the headline inflation rate; and (d) it is in accordance with thecommon international practice of excluding food- and energy-related components of the CPI. Given

that core inflation is a relatively new concept for the Filipino public in general, policymakers believedthat the simplicity of the exclusion method can facilitate greater understanding by the public andconsequently, help build credibility in the use of core inflation.

11. What specific items were excluded in order to estimate core inflation?

The items to be excluded from the definition of core inflation, based on the list of CPI components andtheir corresponding CPI weights (2000=100) are as follows:

(a) Rice (9.4 percent)(b) Corn (0.9 percent)(c) Fruits & Vegetables (5.3 percent)(d) LPG (1.3 percent)

(e) Kerosene (0.3 percent)(f) Oil, Gasoline and Diesel (1.3 percent)

Together, the above excluded items account for 18.4 percent of the CPI. The list of excluded itemsshall be reviewed by the NSCB Board and the Technical Committee on Price Statistics (TCPS)whenever the CPI data is rebased.

12. Is it possible to cite an example of the numerical computation of core inflation based onthe official definition?

Yes. For illustration purposes, the following table presents a sample computation of core inflation forJuly 2004. The core inflation rate for a given month (in this case July 2004) is computed by taking theproduct of the inflation rate for each individual CPI component and the corresponding adjusted CPI

weight, and adding up the products across all components. The sum of the column labeled Inflation XAdjusted Weight is the core inflation rate for the month. Note that the actualcomputation involvesdisaggregated CPI datafor example, food items would be broken down into its sub-components,which include meat, eggs, and so on.


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13. Which government agency will generate the official core inflation data?

In February 2004, the NSO began generating and publishing the official rate of core inflation, startingwith the data for the month of January 2004, alongside the existing headline inflation rate.

14. Will core inflation replace the current CPI or headline inflation published by the NSO?

No. Core inflation is not intended as a replacement for headline inflation, but as a complementaryindicator of the general movement in prices of goods and services.

15. Where does core inflation fit into the BSPs inflation targeting framework?

Under the BSPs inflation targeting framework, the annual inflation target is still defined in terms ofthe headline inflation rate. The BSP plans to use the official measure of core inflation as acomplementary indicator of consumer price movements. Thus, it would serve as an additional input tomonetary policy analysis. Moving forward, the BSP plans to use core inflation as the target measure ofinflation.

16. Is there any program that will help explain and popularize the concept of core inflation?

Yes. A task force of the inter-agency committee on price statistics composed of NSO, BSP, SRTC andNSCB will be conducting an information campaign on core inflation and its uses. The information drive

will involve the distribution of informational materials and the conduct of presentations to the public invarious areas of the country.


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Inflation Rate- the rate of change in the weighted average prices of goods and services typically

purchased by consumers. The weights of the goods and services are based on their corresponding share to

the Consumer Price Index (CPI) basket, i.e., the standard basket of goods and services purchased by a

typical household. In the Philippines, the composition of the CPI basket is determined from the Family

Income and Expenditure Survey (FIES) periodically conducted by the National Statistics Office (NSO).

Inflation is typically defined as the annual percentage change in the CPI. It indicates how fast or slow the

CPI increases or decreases.

Headline Inflationthe rate of change in the weighted average prices of all goods and services in

the CPI basket.

Core InflationAn alternative measure of inflation that eliminates transitory effects on the CPI,

core inflation removes certain components of the CPI basket that are subject to volatile price

movements, such as food and energy, and other items affected by supply side factors, the price

changes from which are not within the control of monetary policy.

Official Definition - This refers to the rate of change in the CPI which excludes the following items/

commodity groups: rice, corn, fruits and vegetables, and fuel items (gas, liquefied petroleum gas

(LPG), kerosene, gasoline and diesel), which together represent 18.4 percent of the CPI basket.

Core inflation data for 2001-2002 are BSP estimates while the data starting January 2003 are the

official National Statistics Office (NSO) figures.

BSPs Alternative Measures of Core Inflation:

o Net of Selected Volatile Items - This measure refers to the rate of change in the CPI which

excludes the following items/ commodity groups: educational services, fruits and

vegetables, personal services, rentals, recreational services, rice, and corn which together

represent 37.6 percent of the CPI basket.

o Trimmed Mean - represents the average inflation of the (weighted) middle 70 percent in a

lowest-to-highest ranking of year-on-year inflation rates for all CPI components.

o Weighted Median - represents the middle inflation (corresponding to a cumulative CPI

weight of 50 percent) in a lowest-to-highest ranking of year-on-year inflation rates.

M1 or Narrow Moneyconsists of currency in circulation (or currency outside depository

corporations) and peso demand deposits.

M2 or Broad Moneyconsists of M1 plus peso savings and time deposits.

M3 or Broad Money Liabilitiesconsists of M2 plus peso deposit substitutes, such as promissory

notes and commercial papers (i.e., securities other than shares included in broad money).

M4 - consists of M3 plus transferable and other deposits in foreign currency.

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