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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 deposit accounts 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 forwardlooking approach in the pursuit of its primary mandate, which is to ensure price stability. Two intrinsic features 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:

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 the BSP) 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 of government security by the BSP from/to the market for the purpose of increasing/decreasing money supply on a more permanent basis. In such a transaction, the parties do not commit to reverse the transaction in the future, creating a more permanent effect on the banking systems level of money supply. Foreign exchange swaps refer 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 a reverse exchange of the same two currencies at a date further in the future (the second leg) at a rate (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

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 to be 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

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 prima ry 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.

CORE INFLATION
1. What is core inflation? Core inflation is a widely-used measure of the underlying trend or movement in the average consumer prices. 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 the average 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 Family Income 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 of the prices of items in the basket of commodities and services consumed by the typical Filipino household. On the other hand, core inflation measures the change in average consumer prices excluding certain items in the CPI with volatile price movements. As such, core inflation may be viewed as a measure of underlying long-term inflation and as an indicator of future inflation. Core inflation is usually affected by 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 core inflation has been more stable, and has effectively captured price trends by taking out the effects of temporary disturbances or shocks on CPI.

3. Why do we need to measure core inflation? CPI inflation is influenced by factors beyond the control of economic policy and has tended to be historically volatile. Temporary shocks or disturbances in certain areas of the economy may cause it to move away from its long-term trend. In the Philippines, volatility in the CPI inflation rate has been caused by factors such as disturbances in agricultural food supply or movements in international oil prices. Temporary shocks in food and oil prices and other similar disturbances also affect prices. As a result, the headline inflation rate may reach double-digit levels, even though the prices of other CPI components show only mild increases. Core inflation is an indicator of the underlying movement in consumer prices since it takes out the effect of temporary disturbances and shocks that cause prices to surge or decline, independent of economic and monetary policy. Measuring core inflation helps policymakers determine whether current movements in consumer prices represent short-lived disturbances or are part of a permanent trend. Such knowledge is important to the formulation of economic policy, particularly monetary policy. 4. How is core inflation measured or computed? There are a number of methods for estimating core inflation. The most common approach used by many countries is the exclusion method, which computes the core inflation by taking out the prices of a fixed, pre-specified set of items from the CPI basket. The excluded components are considered to be either volatile or susceptible to supply disturbances and would typically consist of food and energy items. This is based on the notion that the markets related with these goods are prone to supply shocks. Some economists advocate the use of statistically-based methods that remove the impact of extreme or outlier price changes (both positive and negative) from the overall inflation rate. The set of excluded items changes each month, depending on which particular items exhibit extreme price movements. The most common statistical measures of core inflation are the trimmed mean and

weighted median. Both measures are derived from a highest-to-lowest (or positive to negative) ranking of individual price changes for each given month. The trimmed mean measure takes the average inflation rate after excluding a specified percentage of extreme positive and negative price changes, while the weighted median simply takes the median inflation rate which corresponds to a cumulative CPI weight of 50 percent from the highest-to-lowest ranking. It is also possible to use econometric techniques to estimate core inflation by estimating or calculating a statistical relationship between inflation and other relevant economic variables. The estimated regression model is then used to generate monthly estimates of core inflation using actual data for the other variables in the model. In the Philippines, the official core inflation measure is computed using the exclusion method. This approach was chosen for the following reasons: ease of construction; understandability by the general public; easy replication and verification by others; increased accountability and transparency of measurement; and timeliness. Answers to question nos. 9-10 provide a more detailed explanation on the choice of core inflation measures. Answer to question no. 12 provides a numerical example. 5. Do other countries monitor core inflation? Yes. Most statistical authorities in other countries publish a measure of core inflation. Among central banks, it has become an international practice to monitor core inflation, irrespective of the monetary policy framework that they use. For instance, non-inflation targeting central banks such as the US Federal Reserve, the Bank of Japan and the Monetary Authority of Singapore also monitor core inflation. 6. How do other countries measure core inflation? The majority of countries employ the exclusion method and define core inflation as the overall price index net of the effects of shocks such as policy changes in taxes, exchange rate, interest rate and items, which exhibit seasonal patterns. The most common items excluded are food and energy since these items are considered traditionally as volatile components of the overall CPI basket. Canada, for example, excludes food, energy and the effects of indirect taxes, while the US excludes food and energy. Thailands core inflation measure excludes raw food and energy prices, while the United Kingdom and New Zealand exclude only interest charges. Peru excludes 9 volatile itemsincluding food, fruits and vegetables, and urban transportcomprising about 21.2 percent of the CPI basket. Meanwhile, Chile uses a statistically-based approach and estimates its core measure by excluding both the largest 20 percent of negative price changes and the largest 8 percent of positive price changes. The table below summarizes the official core inflation measures adopted by other countries as well as the other core inflation measures used internally by their central banks.
Other Measures Used Internally by Central Bank CPI excluding 8 most volatile items (16%)
Canada CPI excluding Food, Energy and Indirect Taxes

Country

Official Core Measure

Weighted Median Trimmed Mean (15%)

Thailand Australia

CPI excluding Fresh Food and Energy (23%) Treasury underlying CPI

Trimmed Mean (10%) Trimmed mean

Weighted Median
New Zealand CPI excluding interest charges

CPI excluding volatile items (30%) Weighted Median


Singapore CPI excluding costs of private road transport and costs of accommodation

Trimmed Mean (15%) Structural Vector Autoregression (VAR) model estimate

Japan

CPI excluding Fresh Food CPI excluding 9 volatile items (food, fruits and vegetables, and urban transport, about 21.2 %) CPI excluding food and energy

Peru

United States United Kingdom

Retail price index excluding mortgage interest Rates (RPIX) CPI excluding 20% with higher (-) variations and 8% with higher (+) variations CPI excluding agricultural food, public services, and transport CPI excluding indirect taxes CPI excluding energy and unprocessed food (IPSEBENE) ULI minus fruits, vegetables, and energy CPI (ULI 1) less mortgage interest payments (MIPS)

Weighted median Trimmed mean (15%)

Chile

Colombia Germany Spain Netherlands

Ireland CPI (ULI 2) excluding MIPS and food and energy Portugal CPI (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 banks such as the central banks from Canada, Czech Republic, Finland, Thailand, South Africa and South Koreause core inflation as the operating target for the conduct of monetary policy.

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

Yes. There is now an official definition of core inflation in the Philippines. The National Statistical Coordination Board (NSCB) through NSCB Resolution No. 6 Series of 2003 has adopted an official definition and methodology for computing core inflation in the Philippines based on the exclusion method. 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 headline CPI 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 and Industry (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) it can be computed at the same time as the headline inflation rate; and (d) it is in accordance with the common 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 believed that the simplicity of the exclusion method can facilitate greater understanding by the public and consequently, 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 and their 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 items shall 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 on the official definition? Yes. For illustration purposes, the following table presents a sample computation of core inflation for July 2004. The core inflation rate for a given month (in this case July 2004) is computed by taking the product 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 X Adjusted Weight is the core inflation rate for the month. Note that the actual computation involves disaggregated CPI datafor example, food items would be broken down into its sub-components, which include meat, eggs, and so on.

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, starting with 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 complementary indicator 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 of the headline inflation rate. The BSP plans to use the official measure of core inflation as a complementary indicator of consumer price movements. Thus, it would serve as an additional input to monetary policy analysis. Moving forward, the BSP plans to use core inflation as the target measure of inflation. 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 and NSCB 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 in various areas of the country.

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 Inflation the rate of change in the weighted average prices of all goods and services in the CPI basket. Core Inflation An 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:

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. 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. 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 Money consists of currency in circulation (or currency outside depository corporations) and peso demand deposits. M2 or Broad Money consists of M1 plus peso savings and time deposits. M3 or Broad Money Liabilities consists 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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