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Fiscal Sustainability
- 1. Sustainable Development and Financial Responsibility Diwa C. Guinigundo Deputy Governor Bangko Sentral ng Pilipinas
- 2. I. Bleak globalscenario Renewed financial volatility Weaker growth prospects IMF WEO September 2011 Growth Outlook Projections 2009 2010 2011 2012 World – 0.6 5.1 4.2 4.3 Advanced economies – 3.7 3.1 1.8 2.2 US – 3.5 3.0 1.6 2.0 Euro Area – 4.2 1.8 1.9 1.4 Emerging & Developing Economies 2.8 7.3 6.6 6.4 Developing Asia 7.2 9.5 8.4 8.4 China 9.2 10.3 9.6 9.5 ASEAN-5 1.7 6.9 5.5 5.7
- 3. Daunting debt challengesGross General Government Debt G7 vs Emerging and Developing Countries 2000-2016(F), Share to GDP Public debt in advanced economies substantially up, exacerbated by Fiscal stimulus package Nationalization of private sector debt
- 4. II. Toward asustainable global growth Country-specific policy commitments toward: Fiscal consolidation Exchange rate flexibility Financial sector repair and reform Structural reforms International coordination to: Reform international financial architecture, IFI’s Strengthen regulatory measures
- 5. Time to rethinkgrowth strategies? US growth model Current account deficits Sectoral imbalances: financial vs real Income inequality EMEs growth model Current account surpluses Precautionary savings Export-orientation US: Total Debt as Share to GDP US: Key Sectors as Share to GDP China: Savings, Consumption and Investment as Share to GDP Source: In Global Rebalancing, Lim Mah Hui (2011)
- 6. Time to rethinkgrowth strategies… Deficit economies should Produce more than they consume Stimulate tradable goods industries Pursue fiscal consolidation Surplus economies should Reduce export dependence Increase intra-regional trade and investment Improve social safety nets Promote regional development in capital markets
- 7. Reforming the internationalfinancial architecture Strengthen policy coordination Formulate coherent solutions to capital flows Regulate shadow banking and systemically important FIs Implement internationally agreed measures Enhance risk management strategies Improve toolkit for global safety nets
- 8. III. Implications forEmerging Market Economies
- 9. Sustaining growth amida low-inflation environment 4.3% Jan-Aug Headline Inflation (2000=100, in percent) An effective policy balance between containing inflation and supporting economic growth IV. Recent economic and financial developments Real GDP and GNI (2000 = 100, in percent) 1H 2011 GDP: 4.0% 1H 2011 GNI: 2.6%
- 10. Prudent monetary policyBSP tightens policy stance for effective liquidity management Liquidity and Bank Lending Jan 2002 – June 2011; in Php billion
- 11. Solo = 16.02%Consolidated = 16.97% NPA Ratio (UBs and KBs) = 3.31% ASSET GROWTH 2001 – May 2011 RETURN ON ASSETS / RETURN ON EQUITY UKBs, As of end-March 2011 CAPITAL ADEQUACY RATIO (CAR) 2001-December 2010 BSP Regulatory Requirement of 10% International Standard of 8% NPL Ratio (UBs and KBs) = 2.80% Pre-crisis Level LOAN AND ASSET QUALITY RATIOS As of end-May 2011 8.1% US$165 bn Ratios in percent (%) ROA = 1.50% ROE =13.03% Philippine banking system is sound and stable
- 12. Philippine financial marketsremain buoyant Philippine Stock Exchange Index January 2009 – September 2011 Peso –USD Daily Average Exchange Rate January 2009 – September 2011 PhP42.41 /US$1 (6 Sept ‘11) Emerging Markets Bond Index Spread January 2009 – September 2011 5-year Credit Default Swaps (in basis points ) January 2009 – September 2011 229 bps (7 Sept ‘11) 171 bps (7 Sept ‘11) 4303.1 index pts (6 Sept ‘11)
- 13. External payments positioncontinues to support growth Overseas Filipinos’ Remittances 2004–June 2011 (US$ billion) Foreign Direct and Portfolio Investments* 2008-Q1 2011 (US$ million) * BOP Concept Balance of Payments 2001-Q1 2011 (US$ million) Gross International Reserves 2004-July 2011 (US$ billion)
- 14. By Maturity Asof end-March 2011 External debt dynamics have improved Short-term debt accounts for only about 11% of external debt Debt maturities average more than 22 years External debt-to-GDP ratio has dropped significantly Total External Debt 2004 – May 2011 11.7 years Private 24.4 years Public 22.6 years Total Average Maturity
- 15. Fiscal outcomes arebetter
- 16. a/ Basedon projections adopted by the Development Budget Coordinating Committee (DBCC) on 4 July2011 b/ Based on NSO data V. Outlook: Sustaining growth Actual Projections a/ 2011 YTD 2011 2012 Headline Inflation (%) 4.3 (Jan-Jul) 3.0 - 5.0 3.0 - 5.0 Dubai Crude Oil (US$/bbl) 101.09 (4 Jan-22 Aug) 90 - 115 90 - 110 Exchange Rate (P/US$) 43.28 (3 Jan-18 Aug) 42 - 45 42 - 45 364-day T-bill Rate (%) 2.71 (10 Jan-8 Aug) 3.0 - 5.0 3.0 - 5.0 LIBOR, 6 mos(%) 0.455 (4 Jan-16 Aug) 0.5 - 1.5 0.5 - 1.5 Exports Growth (%) 4.1 (Jan-Jun) b/ 9.0 - 10.0 12.0 Imports Growth (%) 15.6 (Jan-Jun) b/ 17.0 - 18.0 18.0
- 17. Stoke inflationary pressuresLead to asset price misalignments Undermine financial stability Benefits of capital inflows are well known… But so are the risks. Ease financing constraints Contribute to the development of the financial markets VI. Challenges ahead: volatile capital inflows
- 18. Structural reforms ininvestment and financial policies To improve economy ’s absorptive capacity although this takes time Macroeconomic policies To guard against macroeconomic risks associated with inflow surges Prudential policies To guard against financial stability risks BSP ’s broad contours of policy responses
- 19. V. Role ofthe BSP Monetary Policy The BSP will continue to keep a close watch against any risks to the inflation outlook and stands ready to adjust its policy and prudential settings as necessary to safeguard price stability. Financial Policy The BSP will maintain a well-functioning banking system that will efficiently mobilize funds and channel them to productive uses. External Sector Policy The BSP will continue to promote policies that will help shield the economy against adverse shocks by building a comfortable international reserve cushion and adhering to market-determined exchange rate. Moreover, the BSP will continue to monitor and improve further external debt sustainability.
- 20. BSP advocacies topromote inclusive growth Microfinance Proactive stance in microfinance to support the development of a sustainable microfinance business environment Credit Surety Fund Program (CSFP) Support to the CSFP which provides surety to micro, small and medium enterprise-borrowers that generally are not able to provide collateral to the banks Economic and Financial Learning Program (EFLP) Promote greater public awareness of economic and financial issues and provide information to enable households and businesses to make well-informed economic and financial decisions 19
- 21. Sustainable Development and Financial Responsibility
Editor's Notes
- #2 Good morning, ladies and gentlemen of the University of the Philippines. First of all, let me extend my congratulations to the new president of the University of the Philippines, President Alfredo E. Pascual. He was an important partner of the BSP at the Asian development Bank where he played a pivotal role in that institution’s development goals and strategies. I have to say that today ’s forum on fiscal sustainability is very timely as our counterparts in advanced economies, such as in the US, Europe and Japan, struggle with sovereign debt crises, fiscal consolidation and anemic growth. As is currently unfolding in these economies, there is great evidence of linkages among the financial system, fiscal position and economic growth. They can never be ignored.
- #3 Discussing sustainable development and financial responsibility would always require a global context. Such a global context is not exactly rosy. It is in fact bleak. With a globalized economic and financial system, such bleak scenario would have a great limiting influence to what the rest of the world can do. What makes matters worse is that following the financial crisis in 2008-2009, global recovery has remained uneven and fraught with vulnerabilities. This is particularly true with advanced economies. Apart from their still-recovering financial systems, the US is currently beset by weak growth and the absence of a credible medium-term fiscal plan while the eurozone is plagued by financial strains emanating from the sovereign debt crisis in the euro area periphery. The accumulating signs of weaknesses in key advanced economies, particularly following the downgrade in the credit rating of the US, have drastically increased financial volatility in these economies. The US credit default swap (CDS) spreads have moved up while US bond rates have declined. Meanwhile, government bond spreads in euro-peripheral countries have significantly widened. Volatilities are bad for financial markets because market confidence is undermined. As a result, both investments and economic growth are impeded. The prospects are weak.
- #4 Since the global financial crisis, public debt in advanced economies has increased drastically. The primary reason for this is the sizeable fiscal stimulus packages that were implemented to invigorate economic activity. Moreover, being at the epicenter of the recent crisis, advanced economies pursued substantial nationalization of debts of institutions that were considered as systemically important or are too-big-to-fail. In the coming years, the aging population in these countries is expected to further strain government debt levels. A country with high debt levels is exposed to greater vulnerability to unexpected and sudden changes in investor behavior. The loss of investor confidence could push interest rates up (which will push borrowing costs up) or, worse, could result in the total loss of market access. High debt levels could also restrict the ability of the government to respond to crises, thereby weakening its capability to mitigate the negative impacts of these crises on the domestic economy. It is therefore almost anachronistic to talk about sustainable development in these areas which used to drive the global economic locomotive.
- #5 The global scenario is quite clear: major advanced economies face the ff challenges: High sovereign debt Weak demand High unemployment Fragile financial systems. These are the push factors that bring about volatile commodity prices, capital flows and inflationary pressures in emerging markets including the Philippines. I therefore take the position that sustainable global growth can only be promoted if there are firm policy commitments at the country level, as well as increased coordination and cooperation at the international level. The country-specific policy commitments toward a sustainable and balanced growth include the following: Consolidation of fiscal balance sheets—AE’s need to realize they need to save and to economize. They need to spend more wisely. Greater flexibility in the exchange rate—contrary to what they preach, AE’s actually impede their own FX market such that their own exchange rate is not able to perform their market-clearing role. Continued repair and reform in the financial sector—due to disjointed banking supervision, huge leverage and exposure to bad loans, AE’s financial sector needs some overhauling. Implementation of long-term structural reforms—comprehensive restructuring of AE’s economic system is required: the pension system, subsidies, etc. International coordination is also needed to reform the international financial architecture and strengthen cross-border regulatory measures. This should be a subject of another lecture but in this potion, what I want to stress is that we should review the need for a new alternative international currency, governance reform at both the IMF and the World Bank, some regional arrangement to provide BOP assistance if only to complement the IMF’s. The agenda for the global economy is indeed a very lengthy one.
- #6 At the long-term horizon, structural reforms to correct the macroeconomic imbalances that brought about the 2008-2009 financial crisis should be pursued. The growth models that have been the framework of our economies need re-thinking. The current US growth model relies heavily on debt to finance economic growth. The total debt to GDP ratio in the US rose from 150 percent of GDP in the 1960s to 350 percent of GDP in 2007. This debt-driven growth gave rise to current account deficits and fueled sectoral imbalances in the economy, wherein financial sector expansion overtook the growth in the manufacturing and trade sectors. Moreover, income inequality, coming from the ballooning compensation of CEOs (while wages in the production sector stagnated), inflated household debt via the recycling of excess savings among the rich through the financial system. Meanwhile, the growth model in EMEs, particularly in China, relied on current account surpluses. These surpluses stem from the export-orientation of several EMEs as well as precautionary savings due to the weak social programs in these economies. I don’ t see much problem there except that when the global economy starts shrinking, the markets also shrink and therefore this strategy is hardly sustainable. Add to that the fact that when there is economic shrinkage, excess funds of many emerging markets may not be successfully recycled to finance growth and development. There is what we call flight to quality and what we see is in fact an ironic flow of funds back to the ailing developed economies because their debt instruments are considered safe havens.
- #7 To rebalance the global economy and pave the way toward sustainable growth, both deficit and surplus countries have their roles to fulfill. Deficit countries should produce more than they consume. This includes relying more on exports by stimulating the tradable goods industry. At the same time, there is a need to shift away from the non-tradable sector, namely, the finance and insurance industry as well as the real estate sector. Moreover, the governments in these deficit economies should pursue credible fiscal consolidation programs such that economic growth is sustained by the private sector. On the other hand, surplus economies should mirror the efforts of deficit nations. The export-oriented engine of many EMEs should gradually shift to an increase in domestic consumption. Intra-regional trade and investment should be enhanced such that savings within the region will be spent for the development of the region. Moreover, spending on infrastructure development and on social safety nets should be enhanced. In the long term, the region should be able to expend continuous efforts to further develop a regional capital market that is expected to support intra-regional investment.
- #8 An equally important endeavor at the international level is the reform of the global financial architecture. As was made obvious by the recent global financial crisis, regulatory and supervision gaps exist in the financial system. Toward this end, the following are steps toward strengthening the global financial architecture: Strengthening policy coordination via increased regional and multilateral dialogues; Formulating coherent solutions to the management of capital flows between source and recipient countries.; Regulating the shadow banking industry as well as systemically important financial institutions to mitigate the spread of risks across the global network; Implementing internationally agreed measures such as Basel II and III; Enhancing risk management strategies; and Improving the toolkit for global safety nets. We should always prepare ourselves for the tail events. In this regard, enhancing risk management cannot be over-emphasized. The inter-connectedness of various institutions across a host of financial markets requires the development of macro-prudential techniques to measure and mitigate systemic liquidity risks.
- #9 Apart from the fact that financial imbalances can spill over to the real economy, the 2008-2009 financial crisis also underlines the nexus between monetary and financial stability. The recent crisis has shown that price stability - or more broadly - macroeconomic stability, while a necessary ingredient, is not a sufficient condition for financial stability. Nevertheless, macroeconomic stability is the first line of defense against external vulnerabilities. Let me, now, segue to the implications of the current global scenario on EMEs, particularly the Philippines. The sovereign debt and growth concerns in advanced economies are translated globally through increased risk aversion across global financial markets and fears of another global slowdown. So far, despite growing vulnerabilities, the impacts on major financial market indicators in EMEs remain generally muted. A slight uptick in key market indicators following the announcement of the US credit rating downgrade on 5 August 2011 was observed. But it was not as severe as was seen during the height of the global financial crisis. High debt concerns have shifted to advanced economies; in recent decades, EMEs were at the center of sovereign debt crises. Painful reforms undertaken by EMEs, as well as lessons learned from the previous Asian crisis, have significantly strengthened their position to weather external uncertainties. In the case of the Philippines, austere fiscal measures in the past, which included tax increases, and massive financial reforms to strengthen the banking sector have improved macroeconomic fundamentals. These have provided cushion to the economy from external volatilities.
- #10 As a result, the Philippine economy continues to grow in a relatively low-inflation environment. Domestic activity in the first half of 2011 expanded by an annual rate of 4.0 percent (2000-based prices). This is despite a decline in exports in the second quarter. Consumer spending supported the sustained growth in the second quarter of the year. Meanwhile, headline inflation for the first eight months of 2011 (2000-based) averaged 4.3 percent, well-within the Government target range of 3-5 percent for 2011. The Philippines has been able to strike an effective policy balance of supporting economic growth while maintaining stable inflation by being forward-looking and taking preemptive policy actions. Note: Inflation for August was 4.3 percent (2000-based CPI), from 4.6 in July. Using the 2006-based CPI series, inflation was at 4.7 percent in August, down from 5.1 percent in July, resulting in a year-to-date average inflation of 4.3 percent.
- #11 To illustrate the BSP ’s anticipatory monetary policy, let me briefly go over the recent policy moves which we believe will continue to support growth and keep inflation within the 2011-2012 target. Given evidence of broadening and strengthening inflation pressures, the BSP decided to hike policy rates by 25 basis points on 24 March and by another 25 basis points on 5 May to rein in inflation expectations. These policy rate adjustments are intended to help minimize the overall impact of rising inflation on domestic economic activity by helping to firmly anchor the public ’s inflation expectations. Likewise, the BSP decided to increase the reserve requirement by a total of 2 percentage points, one percentage point each effective 24 June and 5 August. The BSP ’s decision to raise the reserve requirements are preemptive moves to counter any additional inflationary pressures from excess liquidity. It is important that BSP maintains just the right amount of liquidity in the system. Adequate liquidity is a necessary condition for robust credit growth. With relatively low interest rates and healthy demand for credit, bank lending has been consistently registering double-digit growth rates. More importantly, credit continues to be channeled to the productive sectors of the economy
- #12 The appropriate monetary policy of the BSP has allowed the banking sector to grow. Our banking system is characterized by: Solid asset growth: total assets of the Philippine banking system as of May 2011 increased by 8 percent US$165 billion; Good loan and asset quality: as of May 2011, non-performing loans for universal and commercial banks (UKBs) stood at 2.8 percent while non-performing assets were at 3.3 percent. These indicators were far below the pre-Asian crisis ratios; Sustained healthy returns on equity: as of March 2011, return on assets of UKBs stood at 1.5 percent while return on equity was at 13.0 percent, all indicating healthy profits for UKBs; and Strong capitalization that is above international norms: bank capitalization has grown steadily over the years, reflecting robust net profits. In terms of the capital adequacy, UKBs registered CARs of 16.29 percent and 17.32 percent on solo and consolidated bases, respectively. Based on these banking indicators, our banks have continued to perform their central roles of efficiently channeling funds to productive uses as well as managing and distributing risks.
- #13 Meanwhile, our domestic financial markets remained buoyant, reflecting continuous improvement in economic prospects. Sustained foreign exchange inflows have supported the peso. Likewise, the Philippine stock market remains vibrant. Despite the cautious prospects on global growth, including the recent US credit rating downgrade from which the stock index was able to recover quickly, the Philippine stock market continues to rally, boosted by a stable macroeconomy and positive growth outlook. The country’s debt spreads likewise narrow [the spreads went as high as 800 bps at the height of the financial crisis in November 2008], while the emerging bond market index spread remains tight, supported by ample liquidity in the market as well as investor demand for emerging markets’ high-yielding assets.
- #14 On the external sector - Our healthy external payments position is a source of strength for the Philippine economy. In fact, this is one constant strong suit of the Philippine economy that credit rating agencies highlight in their assessments of the Philippines. Our balance of payments position registered a surplus of US$3.5 billion in the first quarter of the year, more than double the US$1.3 billion surplus in the comparable period in 2010. Our headline BOP number for the first seven months of 2011 indicates a surplus of US$6.3 billion against a target of US$6.7 billion for the whole of 2011. The external payments position continues to benefit from strong foreign exchange inflows from foreign portfolio investments, merchandise exports and overseas Filipinos ’ remittances. Likewise, strong foreign exchange inflows over the recent years have provided the BSP the opportunity to build up its gross international reserves (GIR) . The country's GIR stood at US$71.0 billion as of end-July 2011, a comfortable cushion of FX from which the country can draw as a buffer against external shocks. The latest level we reported was US$76 billion.
- #15 The sufficient level of reserves has allowed for a better management of the country ’s external debt. In addition, a debt mix that takes advantage of domestic liquidity further reduced the country ’s external debt burden. As of end-March 2011, total external debt as a percent of GDP was equivalent to 29.5 percent, a significant decline from a few years back when the external debt-to-GDP ratio went as high as 70 percent. In addition, the maturity structure of our foreign currency debt has been calibrated toward long-term maturities, in order to help limit rollover and foreign exchange risks.
- #16 A significant part of the country ’s resilience to external shocks can be attributed to a better fiscal position. The fiscal consolidation program of the government remains on track. After hitting a deficit-to-GDP ratio of 5.32 percent in 2002, the NG embarked on a radical fiscal consolidation program that reformed revenue administration and collection as well as expenditure management. These reforms allowed the NG to arrest the ballooning fiscal shortfall and substantially narrowed the fiscal deficit. More recently, roadblocks to fiscal consolidation reforms are being dismantled to raise revenues and, at the same time, rationalize expenditures. The fiscal commitment shown by the government has contributed much to the country ’s recent credit rating upgrade. The Philippines now stands one notch below investment grade.
- #17 Looking ahead, we foresee that inflation could settle within the official target range of 4.0 percent ± 1.0 percentage point for 2011 and 2012. We believe that inflation within the 3 – 5 percent range supports price stability, which is critical for a predictable planning environment. There are upside and downside risks to future inflation but the BSP ’s central projection suggests that inflation will converge within the target range. As for oil prices, the per barrel price of Dubai crude oil is likely to fall within the DBCC-approved assumption ranges of US$90-115 for 2011 and US$90-110 for 2012. Some structural factors could weigh in on oil price trends and the US Energy Information Administration projects the world oil market to tighten into 2012. In the foreign exchange market, the peso-dollar rate is expected to remain broadly steady against the dollar. Appreciation pressures could persist given expectations of strong dollar inflows into the country owing to a favorable domestic economic outlook and ample global liquidity. The steady inflow of OF remittances and exports receipts, and sufficient level of reserves should also provide support to the peso. Likewise, the trend in the peso would be influenced by external developments, such as the heightened risk aversion arising from concerns over a possible global economic slowdown and mounting concerns over the sovereign debt crisis in some parts of Europe. As for interest rates, indications are pointing to a sustained low interest rate environment, given that monetary policy settings will help ensure that inflation will remain within target. At the same time, the NG ’s commitment to fiscal discipline combined with a liquid financial market should help keep domestic interest rates low. In the global front, interest rates are likely to take their cue from the strength of the global economic recovery. With economic activity in advanced economies expected to remain sluggish, a sharp spike in foreign interest rates is less likely to materialize in the near term. Finally, on merchandise trade, we expect full-year exports and imports growth to be slower in 2011 compared to the previous year considering the high base effect in 2010. This anticipated slowdown reflects the impact of supply chain disruptions from the earthquake and tsunami in Japan as well as the weak global economic activity.
- #18 Let me highlight one important issue that has been brought about by the bleak global scanario: the issue of capital flows from advanced economies to emerging markets including the Philippines. The benefits of capital inflows are well known but so are the risks. On one hand, It is well recognized that increased capital inflows help relax the financing constraints of many emerging economies. Stronger capital inflows tend to have a positive impact on the development of the financial markets. On the other hand, rapidly rising external liquidity and credit growth could challenge the domestic economy ’s capacity to absorb the flows. These could stoke inflationary pressures, lead to asset price misalignments, and undermine financial stability.
- #19 The BSP has broad contours of policy responses. Structural reforms – Structural reforms in investment and financial sectors by encouraging direct investments and developing deeper financial markets would help improve the economy ’s absorptive capacity, although these would be longer-term solution. Macroeconomic policies- In its last two monetary policy meetings, the BSP raised reserve requirements as a pre-emptive move to better manage liquidity. Sustained foreign exchange inflows could expand liquidity and fan inflationary pressures. In the meantime, the BSP continues to allow the peso to determined by the supply and demand of FX, participating in the market only to temper excessive movements and restore order and stability. The BSP has also given regulatory incentives to encourage greater private sector outward flows. The balance between monetary and fiscal policy is also a critical factor in managing capital flows. One long-run option is to mobilize greater public savings. This approach reduces demand pressures on domestic resources and allows an easier monetary stance and lower interest rates, lessening the pull of high interest rates on short-term capital inflows. Nonetheless, few countries have relied on fiscal policy as it is usually too inflexible to be an effective tool for responding to fluctuations in capital movements. Prudential policies - The BSP has a set of prudential tools to guard against financial stability risks. These tools include loan-loss provisions, limits to real estate loan exposure, capital adequacy requirements and regulations on derivatives have been put in place since the Asian financial crisis.
- #20 Moving forward, we need to ensure that the economic gains we have achieved thus far will be sustained. From a monetary policy side, we can only assure our people that the BSP will do its share of ensuring that the macroeconomic environment remains appropriate to sustainable growth of the economy and the viability of our financial system. On monetary policy, to help achieve sustainable and durable economic growth in the years ahead, the BSP will remain firmly committed to its mandate of safeguarding price stability. On financial sector policy, the BSP commits to maintain the stability of the financial system by sustaining key reforms that will strengthen the regulatory and supervisory framework, and enhance responsible risk management by banks. On the external front, the BSP will remain supportive of policies that will help cushion the economy from external shocks. We will continue to maintain a market-determined exchange rate and a comfortable level of reserves. The BSP will also continue to promote external debt sustainability by keeping the country ’s outstanding external debt manageable and within the economy’s capacity to service in an orderly manner.
- #21 Beyond the preservation of monetary and financial stability, the BSP will continue its advocacies to promote inclusive growth and help alleviate poverty. A sustainable economic growth becomes more meaningful if it encompasses all sectors of society. To this end, the BSP will continue to help create an environment of growth marked by financial inclusion. As such, our advocacy programs in microfinance, economic and financial education, and consumer protection shall be pursued with greater vigor. Going forward, the BSP stands firm in its role as an anchor of macroeconomic stability.