BSP warns of the risks of ‘debt monetization’

A banking economist warned that the Bangko Sentral ng Pilipinas may lose its “sterling” credibility in the long run and its independence will be questioned with the implementation of the Bayanihan to Recover as One Act, or Bayanihan 2, which has a de facto “Monetization of Debt”. ING Bank Manila senior economist Nicholas Mapa said in a report that Bayanihan 2 has a provision that will allow BSP to buy up to P850 billion in primary market bonds to assist in debt financing. Debt monetization occurs when the government borrows from the central bank, which eventually prints new money, creating inflationary pressures. President Rodrigo Duterte is expected to enact Bayanihan 2 soon, after it was ratified by the Senate and House of Representatives. The BSP letter already allows the central bank to “advance” P300 billion to the national government through a repurchase agreement with the Treasury Office. “While not technically a debt monetization, if the BTr simply rolls over the repurchase agreement at the end, such a move could constitute a de facto debt monetization,” Mapa said. Mapa said that in addition to the primary market repos, the BSP was active in the secondary bond market, buying roughly P800 billion worth of bonds over the course of the past six months to stabilize market returns while flooding the market with additional liquidity. “The central bank continues to provide much-needed stimulus to the economy on its own as fiscal authorities accumulate funds and yet implement modest stimulus packages,” said Mapa. Mapa cited the move by the Indonesian Ministry of Finance earlier this year when it announced a “burden-sharing” agreement in which the Bank of Indonesia would buy bonds in the primary market to help finance the deficit in the fight against COVID. -19. He said authorities promised the move would be a “unique” incident given the dire circumstances. He said Bank Indonesia faced a firestorm when an Indonesian panel of experts proposed handing over more control of Bank Indonesia’s currency board to the finance ministry, opening the door to successive rounds of debt monetization, once perceived as taboo. in central banking circles. “The practice of the central bank buying debt to help reduce costs has generally been frowned upon as it generally leads to inflation and currency weakness,” said Mapa. He said investor reaction to hints that the Bank of Indonesia would be asked to “share the burden” again in 2021 and 2022 triggered a massive run on the currency, but more importantly, it may have affected the credibility of the central bank as investors question its independence. “If BSP were to allow the continuous renewal of larger repurchase agreements, they may be engaging in de facto debt monetization, which is likely not to be welcomed by the market,” said Mapa. “Judging from investors’ reaction to the Bank Indonesia episode, we can expect extreme market pressure on the currency and fears of a pick-up in inflation. And while the peso remains strong and inflation subdued, the biggest victim in a de facto debt monetization scheme will be the credibility of BSP’s sterling, built on decades of admirable leadership, “he said. Mapa said the BSP earned its distinction and credibility over the years and former Governor Amando Tetangco Jr. was recognized internationally as one of the best in the world. He said losing him at a time as precarious as now would be difficult to rectify. Desperate times do call for desperate measures, but for the most part, the monetary authorities have thrown everything, including the kitchen sink, into the virus, perhaps it is time for other sectors to complement the aggressive measures of BSP, as it would be a shame to see the central bank loses its credibility for the sake of other accolades, ”said Mapa.