Good afternoon.
It is a privilege to join you today. Not only have you, the European Chamber of Commerce of the Philippines, stood the test of time. You have thrived, growing twenty times from fifty-one members to one thousand members today.
The BSP [Bangko Sentral ng Pilipinas] has mainly focused on domestic developments, on price stability, and financial stability. But increasingly, many of the shocks that land on a central bank's desk begin somewhere else on the world map.
A war disrupts oil supply. A tariff raises import prices. A geopolitical conflict disrupts shipping. And the world's safe-haven currency suddenly strengthens.
These events, eventually, show up in the prices that Filipino households pay.
Some events create risks that banks and our markets must somehow endure.
Today, I want to talk about some of those things.
Let me start with the basic framework of central banking.
Most central banks have the mandate for price stability. And some central banks, besides price stability, also have the mandate for financial stability.
And here, I give you some examples. The Bangko Sentral itself has a mandate for both price stability and financial stability.
The Fed [Federal Reserve] is the same. The ECB [European Central Bank] is the same. And the Bank of England is the same.
But there are few central banks that also have a separate institution that focuses on financial stability. That includes China. That includes Japan, Canada, Reserve Bank of Australia, and Bank Indonesia.
So, somewhat different mandates, but everyone focuses on price stability.
When it comes to price stability, let me just be clear.
To operationalize what we mean by price stability, we set an inflation target.
And this will be based on some index of consumer price index.
In our case, our target is 3.0 percent inflation. Many other central banks have a target of 2.0 percent inflation. Mostly, the more developed countries have a target of 2.0 percent.
Three percent is, what I would say, the sweet spot for a country that is growing and that needs changes in relative prices to accommodate that growth, and where some prices are sticky downwards. They do not really adjust.
To accommodate the growth, we need, I think, 3.0 percent. It is about the right number.
So, that is about price stability.
In recent months, the biggest challenge has been a global supply shock.
At the end of February, there was a conflict that started with Iran. Oil prices went up. That is shown by the blue part of the bar.
Now, oil prices going up is not just about energy. It is also about fertilizer. So, food prices also go up.
You might say that it is a global supply shock. There is nothing we can do about a global supply shock. Just wait for the shock to dissipate.
But actually, global supply shocks have second-round effects. They affect many other things, many other prices.
What the BSP can do is work on those second-round effects. So, when we do monetary policy these days, we focus not so much on the global supply shocks, but on the second-round effects.
The gray part of the bar represents the second-round effects. The second-round effects this time around came sooner than usual.
After the invasion of Ukraine in 2022, there was also a supply shock, but the second-round effects came six months later. Now they are here within two months.
And that is partly because expectations have changed. People remember what happened in 2022, and so they tend to adjust prices sooner than before.
So that is the bad news. Inflation has now reached 7.2 percent. That is well above the 3.0 percent target.
And it takes some time for inflation to adjust toward our target.
People have said that we should not raise interest rates because raising interest rates actually raises prices.
But that is if you only look at one moving part of the economy. The economy has many, many moving parts, and the central bank has to take account of those many, many moving parts.
Our main model has eighty-eight equations to take account of these many moving parts. And in the end, the most effective way to lower inflation is to raise interest rates.
In the old days, in the 80s, 70s, central banks used to target money supply. So you tighten money supply in order to lower inflation.
But we found out that, actually, that works through interest rates. And interest rates are the more reliable way to do the same thing.
When you raise interest rates, you are effectively tightening money supply. And that causes inflation to go down. And it is a more effective way to do it.
The good news is, somehow, expectations are well behaved, or what we call well anchored.
Expectations on the left are about headline inflation. And about a year from now, the external forecasters believe inflation will be down to 5.4 percent; twenty-four months ahead, four percent; and then 3.6 percent. So that is reassuring to us. That means whatever we are doing, the market buys it. Whatever we are doing.
More important to us is expectations about core inflation. Core inflation is when you strip out the volatile parts of inflation. And that is a more reliable gauge of the inflationary pressure because it strips out the parts that are about the oil price shock and about the fertilizer shock.
And that is the part of inflation that we can actually influence. In here, inflation is supposed to be down to four percent next year. According to forecasters,
3.4 percent after two years; and then 3.0 percent after three years. It takes a while.
It takes a while. That is just how the economy works.
So, that is the inflation story.
Let me go to the financial stability story and then we talk about 1997, before any of you were born.
In 1995, the World Bank and actually the IMF [International Monetary Fun] agreeing with this, identified what they called the East Asian Miracle. Included were eight of those countries: Hong Kong, Indonesia, Japan, Thailand, Malaysia, Singapore, South Korea, Taiwan.
In July 1997, there was a speculative attack on the currencies of some of these economies.
Those that were hit are those in red: Indonesia, Malaysia, South Korea, Thailand, the Philippines.
The Philippines was not technically one of the countries in the East Asian Miracle. It was kind of a miracle-lite economy. So, it somehow got ensnared in the crisis.
The lesson here is simple: Good times, optimistic times, lead to too much risk taking.
And what financial stability means is you look for the vulnerabilities before confidence turns into fear. So that is the experience of 1997.
What can the central bank do? What we have done is to focus on the banks. And our rules, our supervision, our regulations have become forward-looking.
So, we do not wait for losses to show up. We try to anticipate those losses.
We do stress tests, and then we measure what we call expected loss, not actual loss. We do not wait for the loss to show up. We measure expected loss based on data. And every bank is supposed to do that, and they are supposed to provision against expected loss, not provision against a loss that is already happened.
In this regard, if you look at the numbers, we are in pretty good shape. In regard to capital adequacy, the global standard is 10.0 percent. Our banks are at 15.6 percent.
In terms of liquidity coverage, banks are supposed to do scenarios. What happens to deposits if there is a run? A 30-day run?
They have to have enough liquidity to face that run.
Banks now in the Philippines have 155 percent liquidity coverage. So, based on the stress scenarios, they can cover more than 150 percent of the anticipated deposit runs.
There are other metrics that also suggest that our banks have been somewhat conservative, and, therefore, in pretty good shape.
The other thing that we have done is that we have looked at all the banks, and we have identified the ones that we think will be systemic once they fail. Most of them are big banks, but not all of them. Some of them are just banks that specialize in something that the economy really needs.
And then we give those banks a hard time.
We monitor them more closely than we monitor other banks. And then we worry: If one of those banks fails, what do we do? How do we provide emergency liquidity?
If it is what we call a going concern, how do we find another bank that can take it over, a resolution bank? If it is a gone concern, then we pick up the pieces or try to minimize the effect of this failure on the system.
So that is the new banking supervision. It is not just us. Many of our friends in Europe and many of our friends in Latin America are doing the same thing.
The most recent kind of optimism, I would say, is AI [artificial intelligence].
So, the question we face is: Are we now getting too bullish about AI? The worry seems to be that this might be like the dot-com bubble of the late 1990s.
Some of you were old enough to remember that.
In the dot-com bubble, the Nasdaq [Composite] Index lost 70 percent of its value. Now you have NVIDIA, which is the biggest AI firm. They produce chips for AI. It has gained four hundred percent since 2024.
Four hundred percent. Meteoric, meteoric rise.
The question is: Does this rise in the stock price, just in its financing massive investment, does this massive investment justify the expected returns that AI firms deliver?
It is not just NVIDIA. NVIDIA is just the most glaring example. But Meta, Alphabet, Amazon, Microsoft. These are the other AI firms. There are AI firms like OpenAI or Anthropic, but they are not listed in the stock market. They plan to be listed, but for now they are not listed. So, they are not part of what might be a dot-com bubble. But they are also investing very heavily.
And AI firms in general are also borrowing heavily from the bond market. This is a recent phenomenon.
They themselves got worried about the dot-com bubble, so they started to move away from the stock market and move to the bond market, which is affecting us because that means our yields are higher than otherwise. They are crowding out our investments.
So, that is the story. Here is what an old chairman of the Fed said, William McChesney Martin. He was chairman of the Fed from 1951 to 1970. He said, "The job of the Federal Reserve is to take away the punch bowl just when the party is getting good."
That is easier said than done. Actually, we do not know how to take away the punch bowl.
What we could do is to make sure the banks are not overexposed to NVIDIA or other firms that might be overborrowing. And then try to pick up the pieces if something goes bad.
In 1997, by the way, several banks actually failed. There was the Orient Bank. There was Urban Bank. You might remember those names that failed.
What the BSP can do is resolve these bank problems in an orderly way, so it does not affect the system.
So that is what I have for you.
I brought [Deputy Governor] Zeno Abenoja to answer the hard questions. Thank you.