i

i

FOREWORD

he primary objective of monetary policy is to promote a low and stable rate of inflation conducive to a balanced and sustainable economic growth. The adoption in January

2002 of the inflation targeting framework for monetary policy was aimed at helping to fulfill this objective.

One of the key features of inflation targeting is greater transparency, which means greater disclosure and communication by the BSP of its policy actions and decisions. This Inflation Report is published by the BSP as part of its transparency mechanisms under inflation targeting. The objectives of this Inflation Report are: (i) to identify the risks to price stability and discuss their implications for monetary policy; and (ii) to document the economic analysis behind the formulation of monetary policy and convey to the public the overall thinking behind the BSPs decisions on monetary policy. The broad aim is to make monetary policy easier for the public to understand and enable them to better monitor the BSPs commitment to the inflation target, thereby helping both in anchoring inflation expectations and encouraging informed debate on monetary policy issues.

The governments target for annual headline inflation under the inflation targeting

framework has been maintained at 4.0 percent 1.0 percentage point (ppt) for 2014. For 2015-2016, the medium-term inflation target has been set at 3.0 percent 1.0 ppt by the Development Budget Coordination Committee (DBCC) to be consistent with the desired disinflation path over the medium term, favorable trends in the structure of inflation, and expected higher capacity of the economy for growth under a low inflation environment.

The report is published on a quarterly basis, presenting a survey of the various factors

affecting inflation. These include recent price and cost developments, inflation expectations, prospects for aggregate demand and output, labor market conditions, monetary and financial market conditions, fiscal developments, and the international environment. A section is devoted to a discussion of monetary policy developments in the most recent, as well as a comprehensive analysis of the BSPs view of the inflation outlook for the policy horizon.

The Monetary Board approved this Inflation Report at its meeting on

25 September 2014.

AMANDO M. TETANGCO, JR. Governor

3 October 2014

T

ii

List of Acronyms, Abbreviations, and Symbols AE Advanced economy AFF AHFF AMCs

Agriculture, Fishery, and Forestry Agriculture, Hunting, Forestry and Fishing Asset Management Companies

AP Asia Pacific AL Auto Loans BES BGC BIR

Business Expectations Survey Bonifacio Global City Bureau of Internal Revenue

BIS Bank for International Settlements BOC Bureau of Customs BPO Business Process Outsourcing BTr Bureau of the Treasury CAMPI Chamber of Automotive Manufacturers of the Philippines, Inc. CAR Capital Adequacy Ratio CBD Central Business District CCRs Credit Card Receivables CES Consumer Expectations Survey CDS Credit Default Swaps CI Confidence Index CPI DAA DDA DBCC DOF EIA

Consumer Price Index Deferred Accounting Adjustment Demand Deposit Account Development Budget Coordination Committee Department of Finance US Energy Information Administration

EM Emerging Market EMBI ERC

JP Morgan Emerging Market Bond Index Energy Regulatory Commission

EU European Union FAO FPI

Food and Agriculture Organization Food Price Index

GDP Gross Domestic Product GNI Gross National Income GRAM GS

Generation Rate Adjustment Mechanism Government Securities

ICERA Incremental Currency Exchange Rate Adjustment IEA International Energy Agency IMF International Monetary Fund IPP Independent Power Producer LFS Labor Force Survey LPG Liquefied Petroleum Gas LTFRB MB

Land Transportation Franchising and Regulatory Board Monetary Board

MEM Multi-Equation Model

iii

MENA Middle East and North Africa Meralco Manila Electric Company MISSI Monthly Integrated Survey of Selected Industries MTP NBQBs

Major Trading Partner Non-Bank Financial Institutions with Quasi-Banking Functions

NCCP National Council for Commuters Protection NDA NEDA NEER

Net Domestic Assets National Economic and Development Authority Nominal Effective Exchange Rate

NFA Net Foreign Assets; National Food Authority NG NGCP

National Government National Grid Corporation of the Philippines

NPC National Power Corporation NPI Net Primary Income NPLs Non-performing loans O&O Offshoring and Outsourcing OECD Organization for Economic Cooperation and Development OPEC OF

Organization of the Petroleum Exporting Countries Overseas Filipinos

PSA PBR PMI PSALM

Philippine Statistics Authority Performance-Based Rate Purchasing Managers Index Power Sector Assets and Liabilities Management Corporation

PSEi Philippine Stock Exchange Composite Index PSIC Philippine Standard Industrial Classification R&I RB RDA

Rating and Investment Information Inc. Rural Banks Reserve Deposit Account

REER Real Effective Exchange Rate ROP Republic of the Philippines RP RR

Repurchase Reserve Requirement

RREL Residential and Real Estate Loans RRP RWA

Reverse Repurchase Risk Weighted Assets

SEM SMS

Single-Equation Model Short Message Service

SDA Special Deposit Account TCS TLP

Transportation, Communications, and Storage Total Loan Portfolio

U/KBs VAPI VOP

Universal/commercial banks Value of production index Volume of production index

WEO WESM

World Economic Outlook Wholesale Electricity Spot Market

iv

THE MONETARY POLICY OF THE BANGKO SENTRAL NG PILIPINAS

The BSP Mandate The BSPs main responsibility is to formulate and implement policy in the areas of money, banking and credit, with the primary objective of maintaining stable prices conducive to a balanced and sustainable economic growth in the Philippines. The BSP also aims to promote and preserve monetary stability and the convertibility of the national currency. Monetary Policy Instruments The BSPs primary monetary policy instrument is its overnight reverse repurchase (RRP) or borrowing rate. Other instruments to implement the desired monetary policy stance to achieve the inflation target include (a) increasing/decreasing the reserve requirement; (b) encouraging/discouraging deposits in the special deposit account (SDA) facility by banks and trust entities of BSP-supervised financial institutions; (c) adjusting the rediscount rate on loans extended to banking institutions on a short-term basis against eligible collateral of banks borrowers; and (d) outright sales/purchases of the BSPs holdings of government securities. Policy Target The BSPs target for monetary policy uses the Consumer Price Index (CPI) or headline inflation rate, which is compiled and released to the public by the National Statistics Office (NSO). The policy target is set by the Development Budget Coordination Committee (DBCC)1 in consultation with the BSP. The inflation target for 2014 was set at 4.0 percent 1.0 ppt. For 2015-2016, the medium-term inflation target was reduced to 3.0 percent 1.0 ppt.2 BSPs Explanation Clauses These are the predefined set of acceptable circumstances under which an inflation-targeting central bank may fail to achieve its inflation target. These clauses reflect the fact that there are limits to the effectiveness of monetary policy and that deviations from the inflation target may sometimes occur because of factors beyond the control of the central bank. Under the inflation targeting framework of the BSP, these exemptions include inflation pressures arising from: (a) volatility in the prices of agricultural products; (b) natural calamities or events that affect a major part of the economy; (c) volatility in the prices of oil products; and (d) significant government policy changes that directly affect prices such as changes in the tax structure, incentives, and subsidies.

1 The DBCC, created under Executive Order (E.O.) No. 232 dated 14 May 1970, is an inter-agency committee tasked primarily to formulate the National Government's fiscal program. It is composed of the Office of the President (OP), Department of Budget and Management (DBM), National Economic and Development Authority (NEDA), and the Department of Finance (DOF). The BSP attends the Committee meetings as a resource agency.

2 The inflation target range for 2015-2016 was announced on 13 December 2012.

v

The Monetary Board The powers and functions of the BSP, such as the conduct of monetary policy and the supervision over the banking system, are exercised by its Monetary Board, which has seven members appointed by the President of the Philippines. Starting in 2012, the Monetary Board will hold eight (8) monetary policy meetings in a year to review and decide on the stance of monetary policy. Prior to 2012, monetary policy meetings were held every six weeks while prior to July 2006, meetings were held every four weeks during the 2002 July 2006 period.

Chairman Amando M. Tetangco, Jr. Members Cesar V. Purisima

Alfredo C. Antonio

Felipe M. Medalla

Armando L. Suratos

Juan D. De Zuiga, Jr.

Valentin A. Araneta

The Advisory Committee The Advisory Committee was established as an integral part of the institutional setting for inflation targeting. It is tasked to deliberate, discuss, and make recommendations on monetary policy to the Monetary Board. Like the Monetary Board, the Committee will meet eight times a year (beginning in January 2012) but may also meet between regular meetings, whenever deemed necessary.

Chairman Amando M. Tetangco, Jr. Governor

Members Diwa C. Guinigundo

Deputy Governor Monetary Stability Sector

Nestor A. Espenilla, Jr. Deputy Governor Supervision and Examination Sector

Ma. Cyd N. Tuao-Amador

Assistant Governor Monetary Policy Sub-Sector

Ma. Ramona GDT Santiago Assistant Governor Treasury Department

vi

2014 SCHEDULE OF MONETARY POLICY MEETINGS, INFLATION REPORT PRESS CONFERENCE AND PUBLICATION OF MB HIGHLIGHTS

Period Advisory

Committee (AC) Meeting

Monetary Board (MB)

Meeting

MB Highlights Publication

Inflation Report (IR) Press

Conference

2

0

1

4

Jan 9 (Thursday) 12 Dec 2013 MB meeting

24 (Friday) Fourth Quarter 2013 IR

Feb 3 (Monday) AC Meeting No. 1

6 (Thursday) MB Meeting No. 1

Mar 21 (Friday) AC Meeting No. 2

27 (Thursday) MB Meeting No. 2

6 (Thursday) 6 Feb 2014 MB meeting

Apr 24 (Thursday) 27 Mar 2014 MB meeting

28 (Monday) First Quarter 2014 IR

May 2 (Friday) AC Meeting No. 3

8 (Thursday) MB Meeting No. 3

Jun 13 (Friday) AC Meeting No. 4

19 (Thursday) MB Meeting No. 4

5 (Thursday) 8 May 2014 MB meeting

Jul 28 (Monday) AC Meeting No. 5

31 (Thursday) MB Meeting No. 5

17 (Thursday) 19 Jun 2014 MB meeting

11 (Friday) Second Quarter 2014 IR

Aug 28 (Thursday) 31 Jul 2014 MB meeting

Sep 5 (Friday) AC Meeting No. 6

11 (Thursday) MB Meeting No. 6

Oct 17 (Friday) AC Meeting No. 7

23 (Thursday) MB Meeting No. 7

9 (Thursday) 11 Sep 2014 MB meeting

3 (Friday) Third Quarter 2014 IR

Nov 20 (Thursday) 23 Oct 2014 MB meeting

Dec 5 (Friday) AC Meeting No. 8

11 (Thursday) MB Meeting No. 8

8 Jan 2015 (Thursday) 11 Dec 2014 MB meeting

vii

CONTENTS

Overview 1

I. Inflation and Real Sector Developments 3

Prices 3

Box Article: Inflation for the Poorest 30% of Philippine Households 5

Private Sector Economists Inflation Forecasts

8

Aggregate Demand and Supply 12

Aggregate Demand 12

Other Demand Indicators 14 Aggregate Supply 22

Labor Market Conditions 23

II. Monetary and Financial Market Conditions

24

Domestic Liquidity and Credit Conditions 24

Interest Rates 29

Financial Market Conditions

31

Banking System 34

Exchange Rate

37

III. Fiscal Developments IV. External Developments

40

41

V. Monetary Policy Developments

46

VI. Inflation Outlook 47

BSP Inflation Forecasts Risks to the Inflation Outlook

VII. Implications for the Monetary Policy Stance

Summary of Monetary Policy Decisions

47

51

54

57

1

OVERVIEW3

Inflation rises further on higher food prices. Yearonyear (yoy) headline inflation increased to 4.6 percent4 in Q3 2014 (July-August) from the quarter- and year-ago rates of 4.4 percent and 2.4 percent, respectively. Nonetheless, the resulting year-to-date (ytd) inflation rate of 4.4 percent remained within the Governments inflation target range of 4.0 percent 1.0 percentage point (ppt) for 2014. The continued uptrend in headline inflation was driven mainly by the higher prices of food owing to tight domestic supply conditions, triggered by weather-related production disruptions and supply-side bottlenecks. At the same time, the official core inflation rose to 3.2 percent in Q3 2014 from 3.0 percent in Q2 2014 and 2.1 percent in Q3 2013. Two out of three alternative measures of core inflation estimated by the BSP were also higher during the review period. Meanwhile, the number of items with inflation rates greater than the threshold of 5.0 percent (the upper end of the 2014 inflation target) was unchanged at 30 items, accounting for 28.5 percent of the CPI basket.

Inflation expectations are stable but are settling at the upper end of the 2015-2016 target band. Results of the BSPs survey of private sector economists for August 2014 yielded generally higher mean inflation forecasts for 2014, but steady inflation forecasts for 2015-2016 relative to the results in June 2014. Analysts expectations of higher inflation in 2014 were due to possible upticks in food prices, pending petitions for adjustments in utility rates, and looming power shortages. Results of the August 2014 Consensus Economics inflation forecast survey for the country also showed a higher mean inflation forecast for 2014 of 4.3 percent.

Domestic demand continues to be robust. The Philippine economy returned to a higher growth trajectory in Q2 2014 with the higher-than-expected real GDP growth of 6.4 percent in Q2 2014 from 5.6 percent in the previous quarter and 7.9 percent in Q2 2013. The output expansion was underpinned by net exports and household consumption on the expenditure side, reflective of the improvement in external trade in line with the gradual recovery of the global economy and continued favorable domestic demand conditions. At the same time, this growth reflects the broadening output base in the production side, led by sustained improvements in services and more recently in industry. Meanwhile, trends in higher-frequency demand indicators have also remained generally positive in Q3 2014. Vehicle sales continued to post double-digit growth on brisk demand for both passenger cars and commercial vehicles, while the composite Purchasing Managers Index (PMI) remained firmly above the 50-point expansion threshold. Over the coming months, domestic demand is likely to be supported by the generally favorable business and consumer sentiment amid robust credit growth and steady improvements in employment conditions.

Global economic activity strengthens in Q2 2014, but growth prospects across countries continue to diverge. Global growth gained traction during the quarter, notably in the US, where the expansion was buoyed by personal consumption expenditure, private fixed investment, and inventory build-up. A rebound was likewise seen in major emerging markets (EMs). Stronger external demand and government stimulus measures provided support to the Chinese economy. In India, output growth was driven by the rebound in manufacturing sector activity. Meanwhile, economic activity contracted in Japan as private consumption and investment fell following the implementation of higher consumption tax in April 2014. The recovery in the euro area meanwhile remained modest with favourable domestic demand and net exports offset by the impact of inventory drawdowns. Going forward, the global economy is likely to proceed on a moderate expansion path, but risks to the global growth outlook remain tilted to the downside. Geopolitical risks in the Middle East and Ukraine-Russia and potential sharp adjustments in long-term yields and risk aversion as monetary policy in the US normalizes represent soft spots for the global economy. Meanwhile, the global inflation environment remains broadly benign. Inflation pressures in AEs continue to be subdued as output gaps are seen to stay substantial even as the recovery gains pace. However, inflation has risen in some emerg7ing economies owing to domestic supply side factors.

3 The analysis contained in this report is based on information as of 10 September 2014. 4 In this report, the quarterly inflation rates (headline, core, food- and non-food inflation) for Q3 2014 were computed as the y-o-y change in the average CPI for July-August 2014 relative to the average CPI for July-September 2013.

2

Financial market conditions improve generally. Investor sentiment was buoyed by reports of favorable domestic Q2 2014 corporate earnings and the stronger-than-expected Q2 2014 GDP growth amid signs of improving geopolitical situation in the Middle East and Ukraine. The rating upgrade received from the Japan- based credit rating agency Rating and Investment Information Inc.(R&I) likewise contributed to the positive mood in the market. Confidence was further lifted by US Fed statements that interest rates will likely remain low for some time after the end of the US Feds bond buying program and the unprecedented monetary stimulus measures by the European Central Bank (ECB). Consequently, the local bourse surged past the 7,100-mark peaking to a 15-month high in August. The countrys 5-year sovereign credit default swap (CDS) spreads also narrowed during the quarter, trading lower than Indonesias and Thailands CDS and close to Malaysias CDS. The peso likewise strengthened in line with the overall appreciation observed among the currencies in the region as global financial market conditions stabilized on the US Fed pronouncement to maintain interest rates at current levels in the foreseeable future. The larger oversubscription in T-bill auctions similarly pointed to strong investor appetite for Philippine government securities (GS), supported by ample market liquidity. Meanwhile, broadly unchanged bank lending standards for both loans to enterprises and household show that banks are prudently managing their risks.

The BSP key policy rates and SDA rate are raised. The BSP decided to increase its key policy interest rates by 25 bps each during its 31 July and 11 September 2014 monetary policy meetings. The interest rate on the SDA was also raised by 25 bps during the 11 September policy meeting. Meanwhile, the reserve requirement ratios were left unchanged during the quarter. The said policy decisions were based on the assessment that the inflation target, particularly for 2015, could be at risk as latest baseline forecasts along with inflation expectations have shifted near the higher end of the 2015 inflation target range. At the same time, the balance of risks to the inflation outlook continued to lean toward the upside. The BSP also deemed it necessary to respond with stronger policy action to rein in inflation expectations as well as preempt potential second-round effects even as previous monetary responses continue to work their way through the economy.

The inflation outlook calls for preemptive policy action. The latest baseline inflation path has shifted upward compared to the previous quarter owing mainly to the higher inflation outturn in July. The inflation forecasts show that the average inflation could settle above the midpoint of the target ranges of 4.0 percent 1.0 ppt in 2014 and 3.0 percent 1.0 ppt in 2015 before easing to around the midpoint of the target range in 2016. The current assessment of the price environment also indicates that the balance of risks to the inflation outlook remains tilted to the upside, with price pressures emanating from the possible further increases in food prices, pending petitions for adjustments in utility rates, and potential power shortages. Thus far, the persistent increases in food prices have yet not translated into considerable second-round effects. Recent wage petitions have not diverged significantly from their historical trends, while there have been no new calls for transport fare adjustments. However, core inflation, which captures underlying price trends, has picked up in Q3 2014, while inflation expectations have hovered close to the upper-end of the 2015-2016 target ranges since the early part of 2014. Thus, monetary authorities remain ready to act preemptively to ensure that inflation expectations and the general price-setting behavior do not become disanchored from the inflation targets. The protracted supply shocks amid strong aggregate demand conditions can also potentially increase the impetus for second-round effects, thus calling for a firmer policy response to help safeguard the inflation target. The broad buoyancy of domestic demand suggests that there is some room for a measured policy response to potential second-round effects. Favorable growth dynamics reflected in solid domestic demand growth in Q2 2014 imply that monetary authorities have some flexibility to undertake a measured monetary policy tightening. Responding preemptively to the rising inflation risks will also provide BSP latitude to assess at future meetings the evolving balance of risks to both inflation and output and helps to avoid the need for sharp adjustments later on. Going forward, the BSP will remain vigilant against a potential build-up in inflation expectations and stands ready to undertake preemptive policy actions as necessary to safeguard its price and financial stability objectives.

3

I. INFLATION AND REAL SECTOR DEVELOPMENTS

Inflation rises further on higher food prices.

0

1

2

3

4

5

6

7

8

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

2009 2010 2011 2012 2013 2014

in p

erce

nt

Quarterly Headline Inflation (2006=100)

Food Non-FoodNon-Alcoholic Beverage Alcoholic Beverage and TobaccoHeadline

Q3 20144.6 pct

Core inflation increases. Alternative Core Inflation Measures

Quarterly averages of year-on-year change

QuarterOfficial

Headline Inflation

Official Core

Inflation

Trimmed

Mean 1/Weighted

Median 2/

Net of Volatile

Items 3/ *2012

Q1

Q2

Q3

Q4

2013

Q1

Q2

Q3

Q4

2014

Q1

Q2

Q3

3.2

3.1

2.9

3.6

3.0

3.0

3.2

2.7

2.4

3.4

4.4

4.1

4.4

4.6

3.7

3.5

3.7

4.1

3.4

2.9

3.8

2.9

2.1

2.9

3.0

3.0

3.0

3.2

3.2

3.0

3.1

3.4

3.2

2.5

3.0

2.3

2.1

2.6

3.6

3.3

3.6

3.8

3.0

2.6

3.2

3.2

3.0

2.3

2.8

2.3

2.0

2.2

3.0

2.6

3.2

3.1

3.4

3.0

3.3

3.9

3.4

3.1

3.9

3.2

2.4

2.9

2.7

2.8

2.6

2.81/ The trimmed mean represents the average inflation rate of the (weighted) middle 70 percent in a lowest

to-highest ranking of year-on-year inflation rates for all CPI components.

2/ The weighted median represents the middle inflation rate (corresponding to a cumulative CPI weight of 50 percent) in a lowest-to-highest ranking of year-on-year inflation rates.

3/ The net of volatile items method excludes the following items: educational services, fruits and vegetables, personal services, rentals, recreational services, rice, and corn.

r/ Revised.

* The series has been recomputed using a new methodology that is aligned with PSAs method of

computing the official core inflation, which re-weights remaining items to comprise 100 percent of the core basket after excluding non-core items. The previous methodology retained the weights of volatile items in the CPI basket while keeping their indices constant at 100.0 from month to month.

Source: PSA, BSP estimates

0

20

40

60

80

100

120

0

10

20

30

40

50

60

70

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

2009 2010 2011 2012 2013 2014

CPI Items with Inflation Rates Above Threshold

Cumulative Weight (in %) No. of Items Above 5% Threshold (RHS)

28.5 pct

30 items

Headline and Core Inflation Headline inflation increased to 4.6 percent in Q3 2014 (July-August) from the quarter- and year-ago rates of 4.4 percent and 2.4 percent, respectively. The resulting ytd inflation rate of 4.4 percent remains within the Governments inflation target range of 4.0 percent 1.0 ppt for 2014. The continued uptrend in headline inflation was driven mainly by the higher prices of food owing to tight domestic supply conditions. Meanwhile, non-food inflation decelerated on slower price increases of domestic petroleum products.

Core inflation, which excludes some food and energy items to measure underlying price pressures, accelerated to 3.2 percent in Q3 2014 (July-August) from 3.0 percent in Q2 2014 and 2.1 percent in Q3 2013. Two out of three alternative measures of core inflation estimated by the BSP were also higher during the review period relative to the rates registered in the previous quarter. In particular, the trimmed mean and net of volatile items measures edged higher to 3.8 percent and 2.8 percent, respectively, from the quarter-ago rates of 3.6 percent and 2.6 percent. Conversely, the weighted median measure decreased slightly to 3.1 percent from 3.2 percent in Q2 2014. The number of items with inflation rates greater than the threshold of 5.0 percent (the upper end of the 2014 inflation target) was unchanged at 30 items in Q3 2014 (July-August). These items accounted for 28.5 percent of the CPI basket, slightly lower than the previous quarters share of 28.9 percent. Grouping the CPI basket into food and non-food components, the number of food items above the 5.0-percent threshold inched up to 17 items in Q3 2014 (July-August) from 14 items in Q2 2014. By contrast, the number of non-food items with inflation rates higher than the threshold decreased to 13 items from 16 items.

4

Tight domestic supply of key food items drives up food inflation.

Inflation Rates for Selected Food ItemsQuarterly averages in percent (2006=100)

Commodity2013 2014

Q2 Q3 Q2 Q3

Food and Non-alcoholic Beverages

2.4 2.2 6.8 7.8

Food 2.3 2.2 7.1 8.2Bread and Cereals 2.2 4.0 10.2 9.9

Rice 1.6 4.5 12.9 12.2Corn 4.9 3.7 5.9 8.4

Meat 2.2 2.0 4.0 5.5

Fish 2.4 1.9 5.4 6.2Milk, Cheese and Eggs 2.1 1.7 2.8 3.9Oils and Fats -7.4 -7.2 4.9 7.4Fruit 5.0 4.3 5.5 6.8Vegetables 4.6 -0.7 9.7 14.7Sugar, Jam, Honey 0.9 -3.7 4.8 7.4Food Products N.E.C. 2.3 3.1 8.7 9.8

Non-alcoholic Beverages 2.7 2.2 1.5 1.7

Alcoholic Beverages andTobacco 31.2 31.1 4.0 3.4

Source of Basic Data: PSA, BSP

Price reductions in domestic petroleum products contributes to lower non-food inflation.

Inflation Rates for Selected Non-Food ItemsQuarterly averages in percent (2006=100)

Commodity2013 2014

Q2 Q3 Q2 Q3

Non-Food 1.9 1.5 2.6 2.4

Clothing and Footwear 3.6 3.0 3.4 3.3Housing, Water, Electricity, 1.4 0.5 3.0 2.5

Gas and Other FuelsElectricity, Gas, and Other Fuels

-0.6 -2.0 5.6 3.9

Furnishings, Household 3.6 2.5 2.5 2.6

Equipment

Health 3.0 2.6 3.0 3.2Transport

Operation of Personal Transport Equipment

-0.2

-1.1

1.0

3.3

1.3

5.6

1.3

2.7

Communication 0.1 0.1 0.1 0.0Recreation and Culture 2.1 2.5 2.0 1.3Education 4.5 4.7 4.8 5.1Restaurant and Miscellaneous 2.4 2.2 1.9 1.7

Goods and Services

Source of Basic Data: PSA, BSP

Food Inflation

Food inflation continued to rise to 8.2 percent in Q3 2014 (July-August) from the quarter-ago rate of 7.1 percent as the prices of all food items, except rice, increased at a faster pace due to tight domestic supply conditions, triggered by recent weather-related production disruptions. Similarly, delays in supply-side response (e.g., failed bidding in rice imports) and bottlenecks in supply chain (e.g., port congestion and changing transportation policies) also contributed to the continued upsurge in food prices. By contrast, alcoholic beverages and tobacco (ABT) inflation declined further to 3.4 percent from 4.0 percent in the previous quarter, partly reflecting the base effects from higher prices of ABT in 2013. It should be noted that prices of ABT rose following the implementation of Republic Act No. 10351, which raised the excise tax on alcohol and tobacco products in January 2013. Non-food inflation Non-food inflation decreased to 2.4 percent in Q3 2014 (July-August) from 2.6 percent in Q2 2014 as a result of slower price increases of electricity, gas, and other fuels (3.9 percent from 5.6 percent) and operation of personal transport equipment (2.7 percent from 5.6 percent), owing to reductions in the prices of domestic petroleum products (e.g., gasoline, diesel, kerosene, and LPG). Favorable US inventory helped ease international oil prices, which were translated to lower domestic oil prices.

5

Box Article: Inflation for the Poorest 30% of Philippine Households There are about 5.4 million Filipino households who belong to the poorest or bottom 30% income group. Of these, 3.6 million households have monthly incomes lower than what is set by the Philippine government as necessary to buy basic food needs (food threshold) and minimum basic food and non-food needs (poverty threshold).5

Monthly Income for Each Decile Class 2012 Food and Poverty Threshold (In Pesos)

Source of basic data: Official Poverty Statistics and Poverty Reduction Programs of the Philippines 2013

A more detailed description of the bottom 30% can be obtained from the 2008 Philippines Poverty Survey which noted the profile of this income group as follows:

1. 67% of heads of the households have at most an elementary education 2. 36% do not have electricity at home 3. 25% have no sanitary toilet 4. 30% do not have access to safe water 5. 50% live in 10 to 29 square meter housing units, many of which are made of light materials.

5 The Philippine Governments (via the NSCB) official approach in constructing poverty lines or defining what is poor and non-poor starts with the construction of representative food menus for urban and rural areas of each region of the country. The menus, prepared by the Food and Nutrition Research Institute (FNRI), consider local consumption patterns and satisfy a minimum nutritional requirement of 2,000 calories per person per day and 80 to 100 percent of recommended daily allowance for vitamins and minerals. Two thresholds have been established: the food threshold and the poverty threshold. Food threshold is the minimum monthly income required for a household (assumed composed of 5 individuals) to meet the basic food needs, which satisfies the nutritional requirements for economically necessary and socially desirable physical activities. Poverty threshold is the minimum monthly income required for a household (assumed composed of 5 individuals) to meet the basic food and non-food requirements. Note that the basic food requirements are currently based on 100% adequacy for the Recommended Energy and Nutrient Intake (RENI) for protein and energy equivalent to an average of 2000 kilocalories per capita, and 80% adequacy for other nutrients. On the other hand, basic non-food requirements, indirectly estimated by obtaining the ratio of food to total basic expenditures from a reference group of families, cover expenditure on: 1) clothing and footwear 2) housing 3) fuel, light, and water 4)maintenance and minor repairs 5) rental of occupied dwelling units 6) medical care 7) education 8) transportation and communication 9) non-durable furnishings 10) household operations and 11)personal care and effects.

6

Such living conditions resonate with the fact that the bottom 30% has a share of only about 11 percent of the countrys GDP while 60% of Philippines GDP accrue to the top 30% income group. This gap in income and living conditions is now aggravated by the difference in inflation rates. While the national or all-income inflation rate has remained within the BSPs target range of 4.0 percent 1.0 ppt, the inflation rate for the bottom 30% has breached the 5% upper bound of the range since December 2013.

Source of basic data: Philippine Statistics Authority

An analysis of the inflation rates show that the said divergence resulted from the following (1) food comprise 70% of the CPI basket for the bottom 30% versus 47% for the national/all-income inflation (2) prices of food, particularly rice, have increased significantly in the past months. The impact of the said CPI basket weights is especially evident in Q1 2014 where 4.5% of the 5.7% inflation for the bottom 30% is attributable to food inflation while 2.4% of the 5.7% inflation is caused by rice price increases. That inflation rate is higher for the bottom 30% is true in almost regions, with Region 8 experiencing the highest inflation rate possibly due to the impact of typhoon Haiyan which devastated farms and destroyed infrastructure causing a spike in transportation and logistics costs.

CPI Weights Bottom 30% versus All Income Commodities with High PPT Contribution to Headline Inflation

7

Source of basic data: Philippine Statistics Authority

The steady increase in the inflation rates for the bottom 30% bears watching given that this income group is most economically sensitive and vulnerable to price increases. Moreover, high inflation can increase the incidence and severity of poverty in the short-run and can exact a toll on the countrys long-run economic development as lower income households, in order to meet food requirements, reduce spending on health and education. Going forward, the BSP will continue to take special interest in and monitor efforts by the Philippine government to improve the countrys supply side management which could include improving the scheduling and monitoring of rice imports, tighter monitoring of retail prices, lowering logistics and shipping costs, and increasing agricultural productivity.

8

Private Sector Economists Inflation Forecasts Mean inflation forecasts for 2014-2016 are generally steady.

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May June July Aug

2013 2014

2014 20152016 target range

BSP Private Sector Economists' Survey Mean forecast for full year, in percent

2014: 4.4

2015: 4.02016: 3.9

2015 2016

Q3 Q4 FY FY FY

1) Al-Amanah Islamic Bank 4.70 4.60 4.60 4.00 4.00

2) Asia ING 4.80 4.60 4.50 3.90 3.60

3) Banco De Oro 4.07 4.03 4.25 3.90 3.90

4) Bangkok Bank 5.00 4.50 4.50 4.00 4.00

5) Bank of Commerce 4.80 4.80 4.50 - -

6) Bank of the Philippine Islands 4.90 4.30 4.40 4.00 -

7) Barclays 4.20 3.80 4.10 3.80 3.50

8) Chinabank 4.80 4.40 4.40 4.00 3.80

9) CTBC Bank 5.00 4.80 4.50 4.50 4.00

10) Deutsche Bank - - 4.20 3.40 -

11) Eastwest Bank 5.00 4.80 4.60 4.15 4.15

12) Global Source 5.00 4.70 4.50 4.00 -

13) IDEA 5.20 4.90 4.60 4.20 4.40

14) Korea Exchange Bank 2.80 2.90 2.90 2.80 2.80

15) Land Bank of the Phils 4.5-4.8 4.6-4.9 4.6-4.9 4.0-4.3 4.0-4.3

16) Maybank 4.30 4.00 4.30 3.50 4.00

17) Maybank-ATR KimEng 4.50 3.80 4.20 3.50 -

18) Metrobank - - 4.50 4.00 4.00

19) Multinat'l Inv. Banc 4.60 4.20 4.30 3.80 -

20) Mizuho 4.80 4.60 4.50 4.30 4.00

21) Nomura 4.90 4.80 4.70 4.20 -

22) Philippine Equity Partners 4.84 4.69 4.49 4.38 -

23) RCBC 4.8-4.9 4.5-4.9 4.4-4.6 3.9-4.3 4.0-4.5

24) Robinsons Bank 4.75-5.0 4.5-5.75 4.25-4.75 4.0-4.5 3.5-40.

25) Security Bank 3.50 3.50 4.30 4.00 3.80

26) Standard Chartered 4.70 4.60 4.40 3.90 3.50

27) UBS 4.70 4.30 4.30 4.50 -

28) Union Bank 4.60 4.90 4.60 4.40 4.30

Median Forecast 4.8 4.6 4.5 4.0 4.0

Mean Forecast 4.6 4.4 4.4 4.0 3.9

High 5.2 5.1 4.8 4.5 4.4

Low 2.8 2.9 2.9 2.8 2.8

Number of observations 26 26 28 27 19

Government Target 4.01.0 3.01.0 3.01.0

Private Sector Forecasts for Inflation, August 2014Annual Percent Change

2014

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

9

Results of the Q3 2014 BES indicate that respondents who expect inflation to go up in the current and next quarters increase.

Results of the Q3 2014 CES show that consumers expect steady inflation over the next 12 months.

Relative to the previous survey, a greater majority of respondents in the Q3 2014 BSP Business Expectations Survey (BES) expect inflation to move up in the current quarter (from a diffusion index of 31.4 percent to 40.2 percent). Similarly, the number of respondents that expect inflation to increase in the next quarter increased (from 28.4 percent to 38.9 percent). In the Q3 2014 BSP Consumer Expectations Survey (CES), consumers anticipate inflation to remain steady at 6.1 percent. This indicated that inflation expectations of consumers are likely to remain stable in the next 12 months as the number of respondents with views of higher inflation was almost unchanged compared to a quarter ago.

International oil prices decline on ample global oil supply and expectations of weakening demand.

20

40

60

80

100

120

140

2008 2009 2010 2011 2012 2013 2014 2015 2016

Pri

ce in

US

do

llars

per

bar

rel

Spot and Estimated Future Prices of Dubai Crude Oil*

*Futures prices derived using Brent crude futures data.

30 June 2014

9 September 2014

Forecasts for 2014 global oil demand decrease.

Energy Prices The average price of Dubai crude oil declined by 3.5 percent q-o-q in Q3 20148 as oil production in the US accelerated to 8.5 million barrels a day in July 2014, the highest since April 1987, according to a US Energy Information Administration (EIA) report. The Organization of Petroleum Exporting Countries (OPEC) likewise boosted oil production by 891,000 barrels a day to 31 million barrels in August, the biggest level in 2014. Expectations of slower demand growth for 2014 following a weaker assessment of the world economy by the International Monetary Fund and the release of weak manufacturing data9 in Europe and China also exerted downward pressure on oil prices. At the same time, the estimated futures prices of Dubai crude oil, which are based on movements in Brent crude oil futures, in Q3 2014 showed a lower path for the rest of 2014 to 2016 compared to the estimates in Q2 2014. In September 2014, the US EIA,10 the OPEC,11 and the International Energy Administration (IEA)12 projected global demand for 2014 to increase by

8 As of 9 September 2014. 9 Markit Economics reported that its euro-area gauge declined by more than initially projected in August, with the index for Italy unexpectedly dropping below 50, reflecting the first contraction in 14 months. In the UK, manufacturing grew the least in more than a year, with spillovers from the weak euro region among the factors cited. Similarly, Chinas manufacturing expanded at a slower pace in August at 51.1, below the median estimate of 51.2 in a Bloomberg survey. 10 EIA, September 2014 Short-Term Energy Outlook, www.eia.doe.gov 11 OPEC, September 2014 Monthly Oil Market Report, www.opec.org 12 IEA, September 2014 Oil Market Report, www.iea.org

10

Tracking the movement of international oil prices, domestic prices of petroleum products go down.

Domestic Retail Pump Prices (peso/liter)*End-quarter prices

Quarter Gasoline Kerosene Diesel LPG

2013

Q1

Q2

Q3

Q4

2014

Q1

Q2

Q3***

51.45

51.95

53.20

55.50

53.75

54.95

52.35

48.45

50.07

51.12

53.07

50.87

51.54

48.99

39.85

42.30

42.90

45.45

44.25

43.70

41.80

40.21

36.83

41.25

49.80

41.73

40.44

38.74

Q-o-Q (2.60) (2.55) (1.90) (1.70)

Y-o-Y (0.85) (2.13) (1.10) (2.51)

* Average retail pump price for the Big Three oil companiesCaltex, Petron, and Shell, Metro Manila prices only.

** Average price for unleaded gasoline

*** Data as of 9 September 2014

Source: Department of Energy (DOE)

Tight supply conditions put upward pressure on electricity prices.

1.0 million barrels a day (mmbd), 1.05 mmbd, and 0.9 mmbd, lower relative to the previous quarters estimates of 1.3 mmbd and 1.14 mmbd, and 1.3 mmbd, respectively. OECDs downward revision of its world oil demand growth was mainly due to the weaker-than-expected performance of the OECD countries while IEA attributed its lower forecast to a weaker outlook for Europe and China. Meanwhile, EIA expects the bulk of the projected increase in world oil consumption over the next two years to still come from non-OECD regions, particularly China. In Q3 2014, the domestic prices of gasoline, kerosene, diesel, and LPG fell by P2.60 per liter, P2.55 per liter, P1.90 per liter, and P1.70 per liter, respectively, relative to their end-Q2 2014 levels. Similarly, compared to year-ago levels, the domestic prices of gasoline, kerosene, diesel, and LPG prices went down by P0.85 per liter, P2.13 per liter, P1.10 per liter, and P2.51 per liter, respectively. Power Power generation charges went up by P0.10 per kilowatt hour (kWh) in July and by P0.23 per kWh in August due to tight supply conditions. Meralco reported that higher generation charge in July was due to the lower dispatch of several power plants following their scheduled and unscheduled outages resulting to tight power supply. The cost of power purchased by Meralco from their suppliers under the Power Supply Agreements (PSAs) and the Independent Power Producers (IPPS) were higher by P0.26 per kWh and P0.10 per kWh, respectively. Meanwhile, the reduction in the Wholesale Electricity Spot Market (WESM) average price of P4.24 per kWh partly offset the higher power rates. WESM prices were

11

lower due to the implementation of the Energy Regulatory Commissions (ERC) secondary price cap13 in the WESM. Meanwhile, transmission, subsidies and system loss charges also increased in July.

In August, total generation charge also went up mainly due to higher prices at the WESM and the increase in the average cost of contracted power supply sourced from the PSAs. Scheduled and forced outages of various plants, aggravated by the impact of Typhoon Glenda led to a shortfall in power supply.14 The damages caused by the typhoon to some transmission and generating facilities limited the output of a number of power plants located in Southern Luzon. This led to the lower dispatch of the affected plants. Meanwhile, universal charge also increased by P0.04 per kWh, as collection for the previously deferred Universal Charge - Missionary Electrification resumed starting August 2014. Potential sources of upside pressures on electricity charges remain. Meralcos existing petitions for rate increases with ERC include the petition to implement the Maximum Average Price for 2012, 2013 and 2015, amended application for a rate increase in the January 2014 billing (consisting of incremental fuel costs and deferred generation cost to be collected monthly for 6 months), and petition for the refund of generation over/under recovery (GOUR), transmission over/under recovery (TOUR), system loss over/under recovery (SLOUR), and lifeline subsidy over/under recovery (LSOUR) for the period January to December 2011. In addition, there are several pending petitions filed by the Power Sector Assets and Liabilities Managements (PSALM) with the ERC for True-Up Adjustments of Fuel and Purchased Power Costs (TAFPPC), Foreign Exchange Related Costs (TAFxA) and Purchased Power Costs and Foreign Exchange Related Costs by the National Power Corporation

13 On 5 May 2014, the ERC issued Resolution No. 8, s. 2014, imposing a secondary cap of P6,245/MWH on the 73rd hour upon breach of the P8,186/MWH 72-hour rolling average Generator Weighted Average Price (GWAP) threshold. The resolution aims to mitigate sustained high prices in the WESM during the supply months of May and June 2014. 14 For the July supply month, a number of power plant units pushed through with their scheduled outages, including Pagbilao 1, and Ilijan 1 & 2. Further depleting supply of power were 20 new forced outages of several power plant units of various durations during the month (due to Typhoon Glenda or otherwise) such as Sta. Rita Units 10, 20 & 30, Calaca 1 & 2, GN Power 1 & 2, Sual 1 & 2, Ilijan 1 & 2, Pagbilao 1 & 2, Masinloc 1 & 2, San Lorenzo Units 50 & 60, Therma Mobile 2 & 4, and Quezon Power, in addition to the continuing forced outage of Sta. Rita 40.

12

(NPC), and NPCs Stranded Debt portion of the universal charge. The National Grid Corporation of the Philippines (NGCP) has also filed several petitions to recover connection charges and residual sub-transmission charges for 2011-2013 and the costs of repair on damages caused by force majeure events such as earthquake, flooding, landslides, and lightning incidents that struck the country in 2011-2012.

Aggregate Demand and Supply The Philippine economy continues to expand at above-trend rate.

Q2 20147.3 pct

Q2 20146.4 pct

0

2

4

6

8

10

12

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

2009 2010 2011 2012 2013 2014

year

-on

-yea

r gr

ow

th in

per

cen

t

GDP and GNI (At Constant Prices)

GDP GNI

Robust consumer spending and net exports drive output growth.

The countrys real gross domestic product (GDP) expanded at a faster pace of 6.4 percent in Q2 2014 from 5.6 percent in the previous quarter. However, this is slower than the 7.9 percent growth in the same quarter a year ago. The faster-than-expected growth in Q2 2014 was driven by services (3.5 ppts contribution to GDP growth) and industry sectors (2.5 ppts) on the production side, and by net exports (4.2 ppts) and household consumption (3.6 ppts) on the expenditure side. These developments reflect the improvement in external trade in line with the gradual recovery of the global economy and continued favorable domestic demand conditions. On a seasonally-adjusted basis, q-o-q GDP growth rose to 1.9 percent in Q2 2014 from 1.4 percent in Q1 2014. First semester GDP growth at 6.0 percent is below the Governments growth target of 6.57.5 percent for 2014. Gross national income (GNI) increased further by 7.3 percent in Q2 2014. Net primary income (NPI) grew by 12.7 percent, owing to the continued strong inflows of overseas Filipinos remittances during the quarter. Aggregate Demand Household consumption, expanding at a slightly slower pace of 5.3 percent in Q2 2014 from the quarter-ago rate of 5.9 percent, continued to account for the stable half of the countrys output at 66.1 percent. The slight slowdown in household consumption could be attributed

13

-40

-30

-20

-10

0

10

20

30

40

50

60

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

2009 2010 2011 2012 2013 2014

year

-on

-yea

r gr

ow

th in

per

cen

t

GDP-Expenditure (At Constant Prices)

HH Consumption Govt Spending Capital Formation5.3 pct 0.0 pct -2.4 pct

Economic PerformanceAt constant 2000 prices

Growth rate (in percent)

Sector 2013 2014Q2 Q1 Q2

By expenditure item

Household consumption 5.1 5.9 5.3Government consumption 12.1 1.9 0.0Capital formation 33.6 9.5 -2.4

Fixed capital formation 13.6 11.0 4.0

Exports -7.7 13.5 10.3

Imports -4.6 10.1 1.4

Source: PSA

mainly to higher consumer prices, particularly food prices, as a result of tight domestic supply conditions. Government spending posted nil growth in Q2 2014 as actual spending continues to be below the programmed budget of the government. In Q2 2014, personal services (PS) only grew by 1.1 percent (from 9.5 percent in Q2 2013) while maintenance and other operating expenditures (MOOE) grew by 7.4 percent (from 27.3 percent). After posting double-digit growth rates in 2013, capital formation contracted in Q2 2014 due largely to inventory drawdown along with the fall in investments in construction and breeding stocks. A withdrawal of inventory from the previous quarters inventory accumulation pulled down GDP growth by 1.9 ppts. Investments in breeding stocks also continued to fall for the fifth consecutive quarter. Similarly, public construction contracted due to lower spending in infrastructures and other capital outlays by the Department of Agriculture (DA) and the Department of Public Works and Highways (DPWH). However, private construction recovered, supported by strong demand for office spaces due to the expansion of the business processing outsourcing (BPO) industry and other multinational firms. Meanwhile, investments in durable equipment declined, reflecting broad-based slowdown across sectors most notably transport equipment. External trade recovered in Q2 2014, reflecting improved global demand. Total exports continued to grow in Q2 2014 due to the expansion in both exports of goods and services. Exports of goods grew by 10.0 percent on account of increased exports of electronic components, while growth in exports of services came mainly from BPO and tourism receipts as reflected in the double-digit growth in miscellaneous services, travel, and insurance. Meanwhile, growth in total imports decelerated due to decline in imports of goods, which offset the higher imports of services.

14

Recent indicators of activity remain generally positive.

Implied land values continue to trend higher.

Office vacancy rate declines due to continued strong demand for office space.

Other Demand Indicators

Trends in higher-frequency demand indicators have also remained generally positive in Q3 2014. Vehicle sales continued to post double-digit growth on brisk demand for both passenger cars and commercial vehicles, while the composite PMI remained firmly above the 50-point expansion threshold. Over the coming months, domestic demand is likely to be supported by the generally favorable business and consumer sentiment amid robust credit growth and steady improvements in employment conditions. Property Prices

Land Values, Metro Manila

Data from Colliers International indicated that implied land values15 in the Makati CBD and Ortigas Center appreciated in Q2 2014 from quarter- and year-ago levels. Implied land values in the Makati CBD reached P366,425/sq.m. in Q2 2014, higher by 3.6 percent and 20.4 percent relative to the levels recorded in Q1 2014 and Q2 2013, respectively. Similarly, implied land values in the Ortigas Center rose by 2.0 percent q-o-q and 7.9 percent y-o-y to P149,365/sq.m. Land values in the Makati CBD are presently at about 86.2 percent of their 1997 levels in nominal terms, but only about 38.4 percent of their 1997 levels in real terms. Likewise, land values in the Ortigas Center were lower than their comparable levels in 1997 in both nominal and real terms by about 76.6 percent and 34.2 percent, respectively.

Vacancy Rates, Metro Manila

The office vacancy rate in the Makati CBD decreased significantly to 2.1 percent in Q2 2014 from the previous quarter level of 4.2 percent. The office vacancy rate in Q2 2014 was also lower than the 3.5 percent recorded a year ago due to continued strong office demand amid limited office supply in the Makati CBD. The office vacancy rate is estimated by Colliers to decline further to 2.0 percent in Q2 2015.

15 In the absence of reported closed transactions, implied land values based on trends are used by Colliers International to monitor prices.

15

Residential vacancy rate is lower on increased occupancy of high-rise residential units.

The residential vacancy rate in the Makati CBD at 10.4 percent in Q2 2014 was slightly lower than the quarter-ago level of 10.9 percent, but higher than the year-ago level of 9.6 percent. Residential vacancy rates decreased due to higher occupancy rates in the Grade A and B high-rise residential segments. Nonetheless, according to Colliers, the residential vacancy rate in the Makati CBD is expected to rise to 11.7 percent in Q2 2015 as more residential units will be delivered by 2014 and 2015.

Office rental values trend higher. Residential rental values increase slightly. Capital values for office and residential buildings are higher.

Rental Values, Metro Manila16 Monthly Grade A office17 rents in the Makati CBD reached P818/sq.m. in Q2 2014, representing an increase of 3.5 percent from the previous quarter.

Similarly, monthly Grade A office rents in the Makati CBD were higher by 10.5 percent relative to Q2 2013. Office rental values for Grade A offices were slightly above their 1997 levels in nominal terms. In real terms, office rental values were about 46.9 percent of the comparable levels in 1997.

Monthly rents for luxury three-bedroom condominium units in the Makati CBD rose to P820/sq.m. in Q2 2014 or a 1.2 percent growth from the previous quarter. Likewise, monthly rents for the 3-bedroom segment were higher by 3.8 percent compared to the year-ago levels. Residential rental values for luxury three-bedroom high-rise units were above their 1997 levels in nominal terms but were only about 77.0 percent of their 1997 levels in real terms. Capital Values, Metro Manila Capital values18 for office buildings in the Makati CBD in Q2 2014 were higher in nominal terms than their quarter- and year-ago levels. Grade A office capital values in the Makati CBD rose to P93,908/sq.m., higher by 3.4 percent and by 9.5 percent compared to the quarter- and year-ago levels, respectively. Grade A office capital

16 Housing rentals account for 13.8 percent of the 2006-based CPI basket. The NSO only surveys rentals ranging from around P300-P10,000/month to compute rent inflation. However, the rental values discussed in this section pertain to high-end rented properties, which may be considered as indicators of wealth and demand. 17 Grade A refers to office space with capital values between P65,000 and P75,000/sq.m.. 18 Probable price that the property would have fetched if sold on the date of the valuation. The valuation includes imputed land and building value.

16

values were also higher than the 1997 levels in nominal terms. Nevertheless, in real terms, office capital values were about 52.7 percent of the comparable levels in 1997. Capital values for luxury residential buildings19 in Makati CBD in Q2 2014 increased from their quarter- and year-ago levels. Average prices for three-bedroom luxury residential condominium units increased by 1.1 percent q-o-q and 7.3 percent y-o-y. Capital values for luxury residential buildings were above their 1997 levels in nominal terms. In real terms, residential capital values were about 63.1 percent of the comparable levels in 1997.

Vehicle sales increase on brisk demand.

Vehicle Sales Overall vehicle sales from the Chamber of Automotive Manufacturers of the Philippines (CAMPI)20 posted double-digit growth in the first two months of Q3 2014. Vehicle sales increased by 35.6 percent y-o-y from the 21.8 percent growth recorded in the previous quarter (April-May 2014). CAMPI noted that aggressive marketing promotions and car launches as well as sustained demand for passenger cars bolstered the strong vehicle sales. Passenger car sales from CAMPI grew by 60.1 percent y-o-y in Q3 2014 (July-August), accruing to a total of 16,314 from 10,188 units sold in the same period in 2013. Meanwhile, commercial vehicle sales which account for 59.0 percent of total vehicle sales, expanded by 22.6 percent in the first two months of Q3 2014. Commercial vehicles sold during the quarter reached 23,532 units from 19,201 units in the same period in 2013.

19 In terms of location, luxury residential units are located within the CBD core and have quality access to/from and have superior visibility from the main avenue. Meanwhile, in terms of general finish, luxury residential units have premium presentation and maintenance. 20 CAMPI represents the local assemblers and manufacturers of vehicle units in the Philippine automotive industry. The following are the active members of CAMPI, (1) Asian Carmakers Corp., (2) CATS Motors, Inc., (3) Columbian Autocar Corp., (4) Honda Cars Philippines, Inc., (5) Isuzu Philippines Corp., (6) Mitsubishi Motors Philippines Corp., (7) Nissan Motor Philippines Corp., (8) Suzuki Philippines Inc., (9) Toyota Motor Philippines Corp. and (10) Universal Motors Corp.

17

Energy sales declines.

Capacity utilization in manufacturing remains above 80 percent.

65

70

75

80

85

90

J FMAMJ J ASOND J FMAMJ J ASOND J FMAMJ J ASOND J FMAMJ J ASOND J FMAMJ J ASOND J FMAMJ J

2009 2010 2011 2012 2013 2014

Monthly Average Capacity Utilization for ManufacturingIn percent

July 2014 = 83.4

Source: PSA

Manufacturing output continues to expand, albeit at a slower pace.

Energy Sales

Total energy sales of Meralco declined by 0.3 percent y-o-y in July 2014, a reversal of the 4.6 percent growth a year-ago. According to Meralco, the decline in total energy sales could be attributed to the effect of Typhoon Glenda on 16 July 2014 where the majority of Meralco customers within their franchise area experienced disruptions in electric power due to damaged electric poles and power lines.

The growth of residential and commercial energy sales slowed down in July to 1.7 percent and 1.0 percent, respectively, from their year- and quarter-ago figures. Meanwhile, industrial energy sales declined by 3.8 percent. As reported by Meralco, households electricity consumption tend to be lower during the cooler months as they lessen their use of air conditioning units. Capacity Utilization The average capacity utilization rate in the manufacturing sector was steady in July 2014 at 83.4 percent based on the NSOs Monthly Integrated Survey of Selected Industries (MISSI). The proportion of establishments that operated at 80 percent or more was 59.5 percent in July 2014. Based on data since 2000, manufacturing companies have been operating above the long-term average of 80.0 percent since 2010. The peak so far was at 83.5 percent in May 2014. Volume and Value of Production Preliminary results of MISSI showed that the value of production index (VaPI) expanded by 7.7 percent in July 2014 from the month-ago growth of 10.1 percent. The growth in VAPI was driven by strong production values of printing, leather products, fabricated metal products, wood and wood products, basic metals, machinery (except electrical), and electrical machinery.

18

-35

-25

-15

-5

5

15

25

35

45

J FMAMJ J ASOND J FMAMJ J ASOND J FMAMJ J ASOND J FMAMJ J ASOND J FMAMJ J ASOND J FMAMJ J

2009 2010 2011 2012 2013 2014

in p

erce

nt

Volume of Production Value of Production

Source: PSA

Volume and Value Indices of Manufacturing Production

July 20149.6 pct

July 20147.7 pct

9.6 pct 7.7 pct

Likewise, the volume of production index (VoPI) grew at a slower pace of 9.6 percent in July 2014 from 13.3 percent in the previous month. The rise in VoPI was attributed to the improved production of printing, fabricated metal products, leather products, beverages, machinery except electrical and electrical machinery.

Business sentiment in Q3 2014 remains positive, but turns more upbeat in Q4 2014.

Business Expectations Survey

Index 2013 2014

Q1 Q2 Q3 Q4 Q1 Q2 Q3

Business Outlook Index

Current Quarter 41.5 54.9 42.8 52.3 37.8 50.7 34.4

Next Quarter 56.4 46.2 60.0 40.7 50.8 48.9 52.9

Source: BSP

Business Expectations Results of the BES21 for Q3 2014 continued to be favorable in Q3 2014 as the overall confidence index (CI) stayed in positive territory at 34.4 percent. The current quarter reading was lower however compared to the 50.7 percent CI recorded in the Q2 2014 survey. For the next quarter (Q4 2014), business outlook turned more upbeat as the next quarter index rose to 52.9 percent from 48.9 percent in the Q2 2014 survey. Business outlook in both NCR and AONCR tracked the same sentiment of businesses at the national levelless sanguine in Q3 2014, but more upbeat in Q4 2014. Respondents attributed the less buoyant outlook in Q3 2014 to expectations of: (a) seasonal slack in demand due to interruption of business activities during the rainy season and lower consumer spending in view of increased expenditures on education and tax payments in the previous quarter; (b) increase in prices of basic commodities and higher overhead costs such as raw materials and utilities; (c) slowdown in business activities as a result of the truck ban and port congestion issues; and (d) political noise brought about the Priority Development Assistance Fund (PDAF) and Disbursement Acceleration Program (DAP) concerns. The sentiment of businesses in the Philippines mirrored the less bullish outlook in the UK, Canada, Germany, New Zealand, Singapore, Hong Kong and India, but was in contrast to the more buoyant views of those in the US and China.

21 The Q3 2014 BES was conducted from 1 July 15 August 2014 among 1,527 firms nationwide, drawn from the Securities and Exchange Commissions Top 7000 Corporations in 2010 and Business Worlds Top 1000 Corporations in 2012.

19

Consumer confidence edges lower in Q3 2014, but remains positive for the year ahead.

Consumer Expectations Survey

Index 2013 2014

Q1 Q2 Q3 Q4 Q1 Q2 Q3

Current Quarter -11.2 -5.7 -7.9 -21.3 -18.8 -17.3 -26.3

Next 3 months 7.8 4.1 5.7 2.8 5.4 0.0 -1.0

Next 12 months 18.5 16.1 15.8 14.1 19.3 15.9 9.7

Source: BSP

Meanwhile, respondents cited the following reasons for their more positive outlook in Q4 2014: expectations of a) brisker business in view of the expected increase in consumer spending during the holiday season; b) expansion in retail trade, infrastructure, power and telecommunication, education, and health care businesses; c) higher exports of garments and metals in line with the recovery of global markets; and d) increase in orders for manufacturing products leading to higher volume of production. The prevailing favorable macroeconomic conditions brought about by the steady growth of overseas Filipinos (OFs) remittances, increase in investment inflows as well as the expected roll-out of major public-private partnership (PPP) projects (e.g., North-South commuter rail and subway system mass transit loop) also boosted business confidence for the next quarter. Consumer Expectations Results of the Q3 2014 CES showed weakened consumer sentiment for the current quarter, with positive sentiment for the year ahead. Overall consumer CI in Q3 2014 decreased to -26.3 percent from -17.3 percent in Q2 2014. This CI indicated that the number of pessimists increased and continued to exceed the number of optimists in Q3 2014. Respondents cited the following reasons for their bearish outlook during the current quarter: (a) rising prices of basic commodities; (b) political concerns over issues like PDAF and DAP; (c) higher household expenses; and (d) concerns over income, employment opportunities, and the business environment. The outlook of consumers in the Philippines mirrored the less upbeat sentiment of consumers in euro area, and United Kingdom, but was in contrast to the optimistic views of those in Australia, Indonesia, Japan, Taiwan, South Korea, and the United States for Q3 2014. For the next quarter (Q4 2014), consumer sentiment declined slightly from a neutral outlook of 0 percent to -1 percent in the current quarters survey as respondents anticipated higher prices

20

of commodities and expressed concerns over the utilization of government funds. Consumer outlook for the next 12 months was likewise less favorable but remained positive.

PMI remains above the 50-point expansion threshold.

Purchasing Managers Index22 The results of the monthly PMI survey suggest that domestic output expansion slowed down in July 2014. The Composite PMI remained firmly above the 50-point threshold23 at 56.8, but was lower than the 59.5 Composite PMI recorded in June 2014 and 57.4 in July 2013. The lower Composite PMI reflected the slowdown in the manufacturing and retail/wholesale (R/W) sectors.

Manufacturing PMI was 55.2 in July, lower than the 56.1 and 56.6 levels registered in June 2014 and July 2013, respectively. Industry players in the manufacturing industry reported lower production due to delays in the delivery of raw materials as a result of bad weather conditions, local truck ban policy, and port congestion problems in July. New orders and production have slowed down, while employment, supplier deliveries, and inventories increased relative to end-Q2 levels. Services PMI in July 2014 was higher at 63.7 compared to 61.2 in the previous month and 58.5 in July 2013. Services PMI increased given new projects and retained contracts carried over from previous months. Key services indicators namely, business activity, new orders, outstanding business, price charge, and average operating costs improved relative to June 2014 levels while employment contracted. The R/W PMI decreased to 52.6 in July 2014 from 58.0 in June 2014 and 54.9 in July 2013. Respondents attributed this to the local truck ban policy and port congestion problems that trapped goods in transit. Key indicators namely, purchases, sales revenues, and employment

22 The PMI for the Philippines is compiled by the Foundation of the Society of Fellows in Supply Management, Inc. (SOFSM), the advocacy arm of PISM. 23 The actual formula used to calculate the PMI assigns weights to each common element and then multiplies them by 1.0 for improvement, 0.5 for no change, and 0 for deterioration. As a result, an index above 50 indicates economic expansion, and an index below 50 implies a contraction. PMI surveys are conducted on the last week of the month.

Source: Philippine Institute of Supply Management (PISM)

21

Export growth slows down on lower shipments of electronic components.

Exports of GoodsGrowth rate (in percent)

Commodity Group2014

Q1 Q2

Electronic Components 11.5 3.8

Agricultural Products -12.7 -1.1

Fishery Products 43.6 -37.8

Apparel and Clothing Accessories

13.3 23.4

Basketworks -1.4 -8.1

Copper -100.0 31.5

Ignition Wiring Sets 13.4 22.1

Metal Components -11.3 -31.7

Petroleum Products -31.2 -67.8

Others 22.4 21.1

Total Exports 14.2 10.0

Source: PSA

Import growth declines as electronic imports falls.

Imports of GoodsGrowth rate (in percent)

Commodity Group2014

Q1 Q2

Electronics -38.9 -49.2

Mineral Fuels 8.3 -4.9

Machinery and Mechanical Appliances

20.5 -4.7

Base Metals 39.4 21.5

Transport Equipment 13.8 9.9

Textile Yarns 14.0 17.9

Electrical Machinery 11.6 22.1

Artificial Resins 43.9 32.8

Chemical Products 36.4 -16.8

Cereals 110.1 38.5

Dairy Products 42.5 -1.9

Medical and Pharmaceutical Products

18.5 9.8

Paper Products 23.8 -12.5

Feedstuff 96.6 50.1

Metalliferous Ores and Metal Scrap

-68.9 -66.7

Others 41.0 19.8

Total Imports 7.5 -3.9

Source: PSA

declined, while supplier deliveries and inventories expanded compared to the indices recorded in the previous month. External Demand Exports Based on the National Accounts data of the Philippine Statistics Agency (PSA), exports of goods grew at a slower rate of 10.0 percent in Q2 2014 from 14.2 percent in the previous quarter. The slowdown in the export performance was due to lower shipments of electronic components (3.8 percent) and decline of the several commodity exports, including fishery products (-37.8 percent), basketworks (-8.1 percent), metal components (-31.7 percent) and petroleum products (-67.8 percent). Imports Imports of goods declined by 3.9 percent in Q2 2014, a reversal of the 7.5 percent growth recorded in the previous quarter. The decrease in imports can be attributed to lower inward shipments of electronics, mineral fuels, machinery and mechanical appliances, chemicals, dairy, paper products, and metalliferous ores and metal scraps.

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The services sector remains the main driver of output growth on the production side.

-10

-5

0

5

10

15

20

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2

2009 2010 2011 2012 2013 2014

year

-on

-yea

r gr

ow

th in

per

cen

t

GDP-Production (At Constant Prices)

Agriculture Industry Services3.6 pct 7.8 pct 6.0 pct

Economic PerformanceAt constant 2000 prices

Growth rate (in percent)

Sector 2013 2014

Q2 Q1 Q2By industrial originAgri, Hunting, Forestry & Fishing -0.2 0.9 3.6

Agriculture and Forestry -0.9 1.7 4.6Fishing 3.3 -3.1 -0.7

Industry 10.5 5.3 7.8

Mining and quarrying 0.3 9.0 1.9Manufacturing 10.3 6.9 10.8Construction 16.6 0.2 1.4Electricity, gas and water supply 7.0 1.0 2.8

Services 7.8 6.8 6.0

Transport., Storage, & Comm. 6.6 7.7 6.3Trade 6.3 6.0 6.6Finance 10.3 5.7 5.9Real estate, Rent, & Bus. Act. 9.5 9.5 8.9Public administration & defense 5.9 6.3 1.2Other services 8.3 5.5 4.1

Source: PSA

Aggregate Supply The services sector, which comprised 57.6 percent of GDP, expanded by 6.0 percent in Q2 2014 from 6.8 percent in the previous quarter and 7.8 percent in Q2 2013. The continued output increase in transport, real estate services, and trade was partly offset by the growth slowdown in financial intermediation, public administration and defense, compulsory social security, and other services. The strong expansion in transport services was due to the robust growth in air transport following the introduction of new routes, fleet expansion, and upgrades. The growth in trade and repair of motor vehicles, wholesale and retail sub-sector also accelerated given sustained growth in vehicle sales and favorable consumer sentiment. Notwithstanding the slowdown in the growth of ownership of dwellings, real estate, renting and business activities continued to be one of the main drivers of growth as renting and other business activities posted double-digit growth rates for five consecutive quarters. The industry sector grew at a faster pace of 7.8 percent in Q2 2014 from 5.3 percent in the previous quarter. The growth of the manufacturing industry, which accelerated to 10.8 percent in Q2 2014 from 6.9 percent in Q1 2014, was the main driver of the expansion in the industry sector. The growth in manufacturing mainly came from food manufactures, radio, television, and communication equipment and apparatus, furniture and fixtures, fabricated metal products, and petroleum and other fuel products. Meanwhile, the contraction in public construction (-12.9 percent) offset the increase in private construction (12.7 percent). Growth in the utilities subsector (electricity, gas, and water supply) was supported by the brisk real estate and trade activities (commercial account), food and beverage, basic non-mineral, as well as steel manufacturing sectors (industrial account). The agriculture, hunting, forestry, and fishery (AHFF) sector rebounded in Q2 2014, growing by 3.6 percent from 0.9 percent in the previous quarter and -0.2 percent in Q2 2013. The growth

23

in the agriculture sub-sector accelerated due to the big turnaround in crop harvest, particularly palay, corn, mango, and other crops. Meanwhile, the fishing sub-sector declined for the third consecutive quarter.

Labor Market Conditions

The unemployment rate declines.

July 2014*6.7 pct

July 2014*18.3 pct

0

5

10

15

20

25

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

2009 2010 2011 2012 2013 2014

in p

erce

nt

Unemployment and Underemployment

Unemployment Underemployment

* Excludes Leyte province

Based on the preliminary results of the July 2014 Labor Force Survey (LFS),24 the unemployment rate continued to fall to 6.7 percent in July 2014 from the quarter- and year-ago rates of 7.0 percent and 7.3 percent, respectively. The number of unemployed persons was lower at 2.8 million in July 2014 from 2.9 million in the previous quarter and 3.0 million in the previous year. Consequently, the employment rate improved further in July 2014, climbing to 93.3 percent from 93.0 percent in April 2014 and 92.7 percent in July 2013. Employed persons were estimated at about 38.5 million, increasing by 2.8 percent y-o-y. All sectors posted employment gains, led by the services sector with a 2.0-ppt contribution to total employment growth. In terms of major occupation groups, the y-o-y increase in the employment level could be traced largely to the higher number of employed farmers, service workers, clerks, and laborers.

Meanwhile, the proportion of underemployed to total employed persons decreased to 18.3 percent in July 2014 from 19.2 percent in July 2013, but was slightly higher than the quarter-ago rate of 18.2 percent.25

24 The July 2014 LFS excludes data on the province of Leyte. 25Underemployed persons include all employed persons who express the desire to have additional hours of work in their present job or an additional job, or to have a new job with longer working hours. Visibly underemployed persons are those who work for less than 40 hours during the reference period and want additional hours of work.

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II. MONETARY AND FINANCIAL MARKET CONDITIONS

Domestic Liquidity and Credit Conditions Domestic liquidity growth decelerates. Loans for production activities underpin solid bank lending growth.

The growth in money supply or M3 decelerated to 18.3 percent in July 2014 from 23.3 percent in end-Q2 2014. Money supply continued to expand due to the sustained demand for credit in the domestic economy. Domestic claims increased by 13.0 percent in July, slightly slower than the 13.8-percent increase at end-Q2 2014, as bank lending remained strong. Meanwhile, net public sector credit decreased by 4.1 percent in July following an expansion of 8.7 percent at the end of the previous quarter, as the deposits of the National Government (NG) increased at a faster pace, reflecting in part the proceeds from the auction of government securities as well as revenue collections of various agencies. The growth in net foreign assets (NFA) was likewise slower at 1.9 percent y-o-y in July from 5.7 percent in end-Q2 2014. The NFA of banks increased as banks foreign assets expanded at a faster pace relative to the growth in their foreign liabilities. Banks foreign assets rose due mainly to the growth in their deposits with other banks and in their foreign loans and receivables. Meanwhile, banks foreign liabilities increased on account of higher deposits of foreign residents as well as placements and deposits made by foreign banks with their local branches. As of July 2014, outstanding loans of commercial banks, net of banks reverse repurchase (RRP) placements with the BSP, grew at a faster rate of 21.8 percent y-o-y relative to the 20.1 percent and 15.8 percent growth posted at end-Q2 2014 and end-Q3 2013, respectively. The continued expansion of bank lending was driven largely by lending to the following productive sectors: real estate, renting, and business services; wholesale and retail trade; manufacturing; electricity, gas and water; and financial intermediation. Meanwhile, loans for household consumption grew at a broadly steady pace of 16.0 percent as of July 2014, reflecting the continued expansion in auto loans and other

25

types of loans (i.e., salary and personal loans), which offset the slight slowdown in the growth of credit card loans. Credit Standards

Most respondent banks maintain credit standards for loans to enterprises.

Results of the Q3 2014 Senior Bank Loan Officers Survey (SLOS)26 showed that most of the respondent banks maintained their credit standards for loans to both enterprises and households during the quarter based on the modal approach.27 This is the 22nd consecutive quarter starting Q2 2009 that majority of banks reported broadly unchanged credit standards.

The diffusion index (DI) approach,28,29 likewise showed unchanged overall credit standards for loans to enterprises as the number of banks indicating tighter credit standards equaled the number of banks that indicated easing credit standards. However, the DI approach pointed to a net tightening of overall credit standards for loans to households in Q3 2014 relative to the previous quarter, with a DI of 9.5 percent. In the previous quarter, credit standards for corporate lending were unchanged, while credit standards for loans to households showed a net tightening. Lending to Enterprises Most banks (93.5 percent of banks that responded to the question) indicated that credit standards for loans to enterprises were kept steady during the quarter using the modal approach. The unchanged overall credit standards was attributed by banks to their steady outlook on the domestic economy as well as specific industries such as manufacturing, real estate, renting and business activities, wholesale and retail trade, and utilities. At the same time, banks

26 The survey consists of questions on loan officers perceptions relating to the overall credit standards of universal/commercial banks (U/KBs) in the Philippines, as well as to factors affecting the supply of and demand for loans by both enterprises and households. Survey questionnaires were sent to all commercial banks, except for one bank that requested not to be included in the survey since it does not engage in corporate and retail lending. Thirty-four banks responded to the current survey representing a response rate of 97.1 percent. As of March 2014, U/KB loans accounted for about 86.4 percent of the banking systems total outstanding loans. 27 In the modal approach, the results of the survey are analyzed by looking at the option with the highest share of responses. 28 In the diffusion index approach, a positive diffusion index (DI) for credit standards indicates that the proportion of banks that have tightened their credit standards are greater compared to those that eased (net tightening), whereas a negative DI for credit standards indicates that more banks have eased their credit standards compared to those that tightened (net easing). 29 From Q1 2010 to Q4 2012 survey rounds, the BSP used largely the DI approach in the analysis of survey results. Beginning in Q1 2013, the BSP used both the modal and DI approaches in assessing the results of the survey.

26

Q1 Q2 Q3 Q4 Q1 Q2 Q3

Tightened considerably 0.0 0.0 3.6 3.3 3.7 3.6 0.0

Tightened somewhat 0.0 3.4 3.6 3.3 0.0 3.6 3.2

Remained basically unchanged 90.3 86.2 89.3 86.7 88.9 85.7 93.5

Eased somewhat 9.7 10.3 3.6 6.7 7.4 7.1 3.2

Eased considerably 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Diffusion Index for Credit Standards -9.7 -6.9 3.6 0.0 -3.7 0.0 0.0

Weighted Diffusion Index for Credit Standards -4.8 -3.4 3.6 1.7 0.0 1.8 0.0

Mean 3.1 3.1 2.9 3.0 3.0 3.0 3.0

Number of banks responding 31.0 29.0 28.0 30.0 27.0 28.0 31.0

General Credit Standards for Loans to Enterprises (Overall)

2013 2014

Note: A positive diffusion index for credit standards indicates that more banks have tightened their credit standards

compared to those that eased (net tightening), whereas a negative diffusion index for credit standards indicates

that more banks have eased their credit standards compared to those that tightened (net easing).

responses indicated unchanged loan covenants for all firm sizes, except for small and medium enterprises (SMEs), and steady use of interest rate floors for top corporations. Collateral requirements, credit line sizes, and loan maturities were also unchanged for micro enterprises.30 By borrower firm size, overall credit standards for large middle-market and micro enterprises were unchanged based on the DI approach. By contrast, credit standards for SMEs showed a slight net easing, while those for top corporations showed a net tightening based on the DI approach. For the next quarter, most of the respondent banks still expect credit standards for loans to enterprises to remain unchanged. However, the percentage of banks foreseeing a slight easing of credit standards for loans to businesses was higher compared to those expecting the opposite. A more favorable outlook on the domestic economy, expected improvements in the profitability and liquidity of banks asset portfolios, increased tolerance for risk, and anticipated improvement in borrowers profile were among the reasons behind the expected net easing of credit standards of respondent banks.

Most respondent banks report unchanged credit standards for loans to households.

Q1 Q2 Q3 Q4 Q1 Q2 Q3

Tightened considerably 0.0 0.0 5.3 4.8 5.0 5.0 4.8

Tightened somewhat 4.2 4.8 0.0 4.8 10.0 0.0 9.5

Remained basically unchanged 87.5 85.7 84.2 85.7 80.0 95.0 81.0

Eased somewhat 8.3 9.5 10.5 4.8 5.0 0.0 4.8

Eased considerably 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Diffusion Index for Credit Standards -4.2 -4.8 -5.3 4.8 10.0 5.0 9.5

Weighted Diffusion Index for Credit Standards-2.1 -2.4 0.0 4.8 7.5 5.0 7.1

Mean 3.0 3.0 3.0 2.9 2.9 2.9 2.9

Number of banks responding 24.0 21.0 19.0 21.0 20.0 20.0 21.0

Note: A positive diffusion index for credit standards indicates that more banks have tightened their

credit standards compared to those that eased (net tightening), whereas a negative diffusion index

for credit standards indicates that more banks have eased their credit standards compared to those

that tightened (net easing).

General Credit Standards for Loans to Households (Overall)

2013 2014

Lending to Households Using the modal approach, the survey results likewise showed that most of the respondent banks (81.0 percent) continued to report unchanged credit standards for loans extended to households. The DI approach, however, indicated a net tightening of overall credit standards for household loans owing to less aggressive competition from banks and non-bank lenders and decreased access of banks to money or bond marker financing. In particular, banks responses indicated stricter collateral requirements and increased use of interest rate floors for all types of household loans. Banks responses also showed net tightening of standards on loan covenants

30 The survey questionnaire identified six specific credit standards: (1) loan margins (price-based); (2) collateral requirements; (3) loan covenants; (4) size of credit lines; (5) length of loan maturities; and (6) interest rate floors. A loan covenant is an agreement or stipulation laid down in loan contracts, particularly contracts with enterprises, under which the borrower pledges either to take certain action (an affirmative covenant), or to refrain from taking certain action (a negative covenant); this is consequently part of the terms and conditions of the loan. Meanwhile, an interest rate floor refers to a minimum interest rate for loans. Greater use of interest rate floor implies tightening while less use indicates otherwise.

27

Loan demand from b