Bangko Sentral ng Pilipinas (BSP) has started lowering interest rates as economic growth moderated and inflation improved. While we expect the central bank to continue cutting rates in the coming months, we believe BSP Governor Eli Remolona Jr. is also planning to reduce banks’ reserve requirements (RR), as he previously hinted.

The current reserve requirement is 9.5%. We think Remolona might lower it by 250 basis points (bps) or 2.5 percentage points before the end of the year, with the first reduction likely to happen soon.

Expect RR redux

Governor Remolona said he would only resume reducing the RR when the BSP was in easing mode. The central bank learned from a past episode when it unexpectedly reduced the RR while it was raising interest rates.

The move shocked investors and was viewed as counterintuitive with the financial market reaction not favorable, highlighting the importance of getting the timing of an RR reduction right. Now that the BSP looking to bring down its borrowing costs from elevated levels to more normal and supportive levels, the time appears ripe for another round of RR reductions. Remolona indicated he would eventually want to bring down RR to 5% in the medium term.

Any given Thursday

Adjustments to the RR were once considered a policy adjustment. However, with the advent of the BSP’s interest rate corridor system and its accompanying liquidity management facilities, any RR reduction has been relegated to a simple operational adjustment.

Since RR changes are not considered policy moves, we believe the upcoming RR reduction could happen on any Thursday (when the Monetary Board meets weekly). It may not necessarily be announced during the regular policy cycle. With the BSP in easing mode, we expect RR reductions to be announced shortly after the Fed policy meeting or perhaps after the Philippines’ September inflation data is released, which could show inflation drop to around 2.3%.

Impact of RR reduction

However, it remains to be seen whether reducing the RR at a time when policy rates remain at elevated levels will translate to increased bank lending and a significant boost to the economy. Banks that have more funds available for lending might choose to deposit this money back with the central bank, where they can earn attractive interest rates of about 6.25%.

As such, should the BSP carry out a 150-bp RR reduction in the near term, banks may become attractive again in the near term. However, caution about its impact on bank lending and overall growth momentum is warranted.

NICHOLAS MAPA is Metrobank’s Chief Economist, Market Strategist, and Head of the Research and Market Strategy Department in the Financial Markets Sector. He graduated from the University of Asia and the Pacific (UA&P) with an undergraduate degree in Humanities and a Master of Science (MSc) in Industrial Economics. He also completed an MA in Economics from Vanderbilt University and an MBA from the Kelley School of Business at Indiana University. He travels regularly with his family, enamored by culture and history. An avid learner, he also reads extensively.