INFLATION REPORT

Third Quarter 2008

Bangko Sentral ng Pilipinas

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 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 rigorous economic analysis behind the conduct of monetary policy and convey to the public the overall thinking behind the BSP’s decisions on monetary policy. The broad aim is to make monetary policy easier for the public to follow and understand and enable them to better monitor the BSP’s commitment to the inflation target, thereby helping both in anchoring inflation expectations and encouraging informed debate on monetary policy issues.

The government’s targets for annual headline inflation under the inflation targeting

framework have been set at 4.0 percent and 3.5 percent for 2008 and 2009, respectively, both with a tolerance interval of ± 1.0 percentage point.

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

factors affecting inflation. These include recent price and cost developments, prospects for aggregate demand and output, monetary and financial market conditions, labor market conditions, fiscal developments, and the international environment. A section is devoted to the BSP’s view of the inflation outlook during the policy horizon. This is followed by a discussion of the implications of the assessment of inflation and economic conditions on the monetary policy settings of the BSP.

The Monetary Board approved this Inflation Report at its meeting on 30 October

2008.    

           AMANDO M. TETANGCO, JR.

Governor                                                                                      

October 2008

T

ii

List of Acronyms, Abbreviations and Symbols AMCs Asset Management Companies ARMM Autonomous Region of Muslim Mindanao BAS Bureau of Agricultural Statistics BES Business Expectations Survey BI Bureau of Immigration BIR Bureau of Internal Revenue BNM Bank Negara Malaysia BNBs Bank Negara Bills BOC Bureau of Customs BOE Bank of England BOJ Bank of Japan BOK Bank of Korea BOT Bank of Thailand BTr Bureau of the Treasury CalPERS California Public Employees’ Retirement System 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 CPI Consumer Price Index DBCC Development Budget Coordinating Committee DCS Depository Corporations Survey ECB European Central Bank ERC Energy Regulatory Commission FBT Food, beverage and tobacco FIREBS Financial institutions, real estate and business services FLW Fuel, light and water FOMC Federal Open Market Committee GDP Gross Domestic Product GNP Gross National Product GRAM Generation Rate Adjustment Mechanism GS Government Securities HICP Harmonized Indices of Consumer Prices ICERA Incremental Currency Exchange Rate Adjustment IMF International Monetary Fund KBs Commercial banks KWH Kilowatt hour LFS Labor Force Survey LPG Liquefied Petroleum Gas LTO Land Transportation Office MAS Monetary Authority of Singapore MEM Multi-Equation Model Meralco Manila Electric Company MISSI Monthly Integrated Survey of Selected Industries MS Monetary Survey MSBs Monetary Stability Bonds MT Metric Tons MTP Major Trading Partner NCR National Capital Region NEER Nominal Effective Exchange Rate NFIA Net Factor Income From Abroad NG National Government NIA National Income Accounts NPC National Power Corporation

iii

NPLs Non-performing loans NSO National Statistics Office OECD OFs

Organization for Economic Cooperation and Development Overseas Filipinos

OMOs Open market operations OPEC Organization of Petroleum Exporting Countries PBC People’s Bank of China PMI Purchasing Managers’ Index PSEi Philippine Stock Exchange Composite Index PSS Postal Savings System PSIC Philippine Standard Industrial Classification PTIC Philippine Telecommunications Investment Corporation RDA Reserve Deposit Account REER Real Effective Exchange Rate RM Reserve Money ROP Republic of the Philippines RP Repurchase RRP Reverse Repurchase RVAT Reformed Value Added Tax SEM Single-Equation Model SDA Special Deposit Account TLP Total Loan Portfolio TMA Truck Manufacturers Association TransCo National Transmission Corporation U/KBs Universal/commercial banks VAPI Value of Production Index VOPI Volume of Production Index WESM Wholesale Electricity Spot Market

 

iv

THE MONETARY POLICY OF THE BANGKO SENTRAL NG PILIPINAS

The BSP Mandate The BSP’s 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 BSP uses various instruments to effect the desired monetary policy stance to achieve the inflation target. These include (a) raising/reducing the BSP's policy interest rates; (b) increasing/decreasing the reserve requirement; (c) encouraging/discouraging deposits in the special deposit account (SDA) facility by banks and trust entities of BSP-supervised financial institutions; (d) increasing/decreasing its rediscount rate on loans extended to banking institutions on a short-term basis against eligible collaterals of banks’ borrowers; and (e) outright sales/purchases of the BSP’s holdings of government securities. The BSP’s primary monetary policy instruments are its overnight reverse repurchases (borrowing) rate and overnight repurchase (lending) rate. Policy Target The BSP uses the Consumer Price Index (CPI) or headline inflation rate which is compiled and released to the public by the National Statistics Office (NSO) as its target for monetary policy. The policy target is set by the Development Budget Coordinating Committee (DBCC)1 in consultation with the BSP. For 2008, the Government’s target for annual headline inflation has been set at 4.0 percent with a tolerance interval of ± 1.0 percentage point. For 2009, the headline inflation target has been set at 3.5 percent ± 1.0 percentage point. BSP’s Explanation Clauses These refer to the predefined set of acceptable circumstances under which an inflation-targeting central bank may fail to achieve its inflation target. These clauses recognize 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 Department of Budget and Management (DBM), National Economic and Development Authority (NEDA), and the Department of Finance (DOF). The BSP sits as a resource agency.

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. Beginning in July 2006, the Monetary Board meets every six weeks to review and decide on the stance of monetary policy. Prior to July 2006, monetary policy meetings by the Monetary Board were held every four weeks.

Chairman Amando M. Tetangco, Jr. Members Peter B. Favila

Raul A. Boncan

Juanita D. Amatong

Nelly F. Villafuerte

Alfredo C. Antonio

Ignacio R. Bunye

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. The Committee meets every six weeks (beginning July 2006) but may also meet in between the regular meetings, whenever it is deemed necessary. Prior to July 2006, the Committee met every four weeks.

Chairman Amando M. Tetangco, Jr.

Governor Members2 Diwa C. Guinigundo

Deputy Governor Monetary Stability Sector

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

Ma. Cyd N. Tuaño-Amador

Managing Director Monetary Policy Sub-Sector

Ma. Ramona GDT Santiago Managing Director Treasury Department

2 The Advisory Committee is supported by a Technical Secretariat composed of officers and staff from the Department of

Economic Research, Center for Monetary and Financial Policy, and the Treasury Department.

vi

Mtg. No. Advisory Committee 1/ Monetary Board 2/ Publication of Monetary Board Highlights 3/

1 28 January, Monday 31 January, Thursday 28 February, Thursday 10 April, Thursday 2 10 March, Monday 13 March, Thursday

3 21 April, Monday 24 April, Thursday 22 May, Thursday

3 2 June, Monday 5 June, Thursday 03 July, Thursday

5 14 July, Monday 17 July, Thursday 14 August, Thursday

6 26 August, Tuesday /a28 August, Thursday 25 September, Thursday

7 6 October, Monday 9 October, Thursday 06 November, Thursday

8 17 November, Monday 20 November, Thursday 18 December, Thursday

9b 15 December, Monday 18 December, Thursday 22 January 2009, Thursday

Notes:

SCHEDULE OF THE MEETINGS ON MONETARY POLICYAND PUBLICATION OF HIGHLIGHTS FOR 2008

2008

starting July 2006. Prior to this, the Advisory Committee and Monetary Board meetings were held every four weeks. 2/ Monetary Board meetings on monetary policy are usually held on the Thursday after the latest Advisory Committee meeting which are

usually held on Monday.. 3/ Under MB Resolution No. 630, the lag in the publication of the highlights of the Monetary Board meetings on monetary policy issues

b/ The AC and the MB meetings will be held two weeks earlier in observance of the Christmas holidays.

1/ Under MB Resolution No. 630, the frequency of meetings of the Advisory Committee and the Monetary Board was set at every six weeks

was reduced to four weeks. Prior to this, the highlights were published six weeks after the reference meeting date. a/ The AC meeting will be held a day later since the scheduled AC meeting date on 25 August 2008 (Monday) coincides with National Heroes' Day.

vii

CONTENTS  

 Overview 1

I. Inflation and Real Sector Developments 3

Prices 3

Aggregate Demand and Supply 13

Labor Market Conditions 23

II. Monetary and Financial Conditions 24

Interest Rates 24

Financial Market Conditions 26

Banking System 28

Exchange Rate 32

Monetary Aggregates 34

Fiscal Developments 36

III. External Developments 37

IV. Monetary Policy Developments 40

V. Inflation Outlook 42

Private Sector Economists’ Inflation Forecasts BSP Inflation Forecasts

Risks to the Inflation Outlook VI. Implications for the Monetary Policy Stance

42

43 46 50

Summary of Monetary Policy Decisions

53

1

OVERVIEW3

Inflation accelerates in Q3 2008. Inflation pressures intensified in July and peaked in August, as headline inflation averaged higher during Q3 2008, driven in large part by the momentum of the global commodity price increases. However, with the abatement of food and oil prices toward the latter part of the quarter, inflation declined in September after 10 months of continued acceleration. Meanwhile, core inflation also averaged higher during the quarter, indicative of the earlier build-up in demand pressures, although there was little additional evidence of second-round effects in September as indicated by the absence of new petitions for wage and transport fare hikes, and easing inflation expectations.

The pace of real sector activity slows down amid the rising cost of fuel and other

basic commodities and the slump in the US economy and its spillovers to other economies. The domestic economy grew at a slower pace in the second quarter, reflecting the adverse impact of higher commodity prices and the slowdown in global growth. Many demand indicators showed some cooling down: slowdown in household spending, lower business and consumer confidence, declining energy sales, and easing demand for energy-related and -intensive goods.

Financial market sentiment remains weak amid worsening global financial

developments. The peso weakened and activity in the stock market turned bearish on heightened concerns about the worsening global financial turmoil. The yield curve of the secondary market for government securities flattened in Q3 2008, reflecting partly a “flight to quality” market sentiment. In addition, bond spreads widened as the financial market strains globally triggered a significant spike in risk aversion against emerging market assets. This turn of events is expected to slow down domestic economic activity further in the short term due to the negative feedback loops from financial markets to the real sector.

Global economic conditions weaken considerably amid the most severe global financial crisis in decades. The global economy is facing its most difficult challenge in many years, hit by the combination of an imminent economic slowdown, still elevated inflation levels, and the most severe global financial turmoil in decades. Going forward, the global financial market upheaval may stunt global demand as a credit crunch resonates through the global economy.

However, domestic liquidity growth continues to increase in Q3 2008. The expansion in

domestic liquidity as of end-August was driven by net domestic assets, as credits to the private sector accelerated. Meanwhile, the expansion in net foreign assets slowed down due largely to the decline in the foreign assets of depository corporations as banks’ investments in foreign securities declined.

The BSP raises its policy rates further in Q3, mindful that inflation control is its

foremost priority. The Monetary Board increased the BSP’s key policy interest rates during the quarter by a cumulative 75 basis points to 6.0 percent for the overnight borrowing or reverse repurchase (RRP) facility and 8.0 percent for the overnight lending or repurchase (RP) facility. At that time, while there were early indications of some easing in global commodity prices, the Board believed that further tightening was needed to address upside risks to the inflation outlook, including evidence of second-round effects as reflected in rising core inflation and inflation expectations, as well as wage and transport fare hikes; continued volatility in oil prices; weaker peso; and possible increases in utility rates.

3 The analyses in this report are based on information as of 30 September 2008.

2

The BSP’s latest assessment is that inflation could settle above the 2008 and 2009

targets. Price pressures will unwind over the next few months, to reach the target-consistent path by 2010. Price pressures started to recede in September after peaking in August, given favorable price conditions in both domestic and international markets as well as the weaker global economic outlook. Early signs of improving inflation expectations are also emerging. However, possible sources of upside risks to inflation remain, including the continued volatility in oil prices, peso depreciation, and possible increase in utility rates. Nonetheless, the stabilization of oil and rice prices has been helpful in cementing inflation expectations going forward.

With the global financial crisis and prospects of a marked slowdown in global

economic growth for 2009, monetary policy will continue to be geared towards the achievement of price stability while exercising flexibility given the presence of significant shocks to the real sector. The BSP’s objectives of promoting price stability and financial market stability are mutually reinforcing since the promotion of the smooth operation of the financial system will, in turn, ensure the effective functioning of the transmission channels for monetary policy. The BSP is firm in its resolve to undertake policy actions that will ensure the soundness and the stability of the banking sector and to strengthen the public’s trust and confidence in the financial system, by making sure that there is sufficient liquidity to fund the growth requirements of the economy.

[Subsequently, on 6 October, the Monetary Board maintained the BSP’s key policy interest rates for the overnight borrowing or reverse repurchase facility at 6.00 percent and 8.00 percent for the overnight lending or repurchase facility. On 17 October, the Monetary Board approved the opening of a US dollar repurchase agreement facility to augment the dollar liquidity in the market. This move is expected to support the orderly functioning of the financial system, which is an effective channel of monetary policy.]

3

I. INFLATION AND REAL SECTOR DEVELOPMENTS Prices

0

2

4

6

8

10

12

14

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Headline Inflation Quarterly average in percent (2000=100)

Q3 2008:12.2

Inflation pressures intensified in July and peaked in August, as headline inflation averaged higher during Q3 2008 driven by the momentum of the global commodity price increases. However, with the abatement of food and oil prices, September inflation declined after 10 months of continued acceleration. Nevertheless, supply constraints and low inventories are expected to persist for some time and the momentum in demand growth in large emerging economies still remains considerable. Supply and demand balance in the commodities market is therefore expected to remain tight. Meanwhile, core inflation also averaged higher during the quarter, indicative of the earlier build-up in demand pressures, although there was little additional evidence of second-round effects in September as indicated in the absence of new petitions for wage and transport fare hikes, and easing inflation expectations.

0

2

4

6

8

10

12

14

2002 2003 2004 2005 2006 2007 2008

Headline Inflation Core Inflation

Headline and Core InflationQuarterly average in percent (2000=100)

Q3 2008

Headline12.2

Core6.9

Headline and Core Inflation Average headline inflation rose to 12.2 percent in Q3 2008 from 9.7 percent in the previous quarter and 2.5 percent in the same quarter a year ago. This was mainly the result of rising inflation from 11.4 percent in June to 12.3 percent in July, and further to 12.5 percent in August. Inflation eased to 11.9 percent in September, but the result was an increase in inflation for the third quarter. Of the 12.2 percent average headline inflation rate for Q2 2008, 8.3 percentage points were attributed to food, of which 4.1 percentage points came from rice. Services contributed 2.0 percentage points while housing and repairs contributed 0.8 percentage point.

Inflation accelerates in Q3 2008.

4

Food and non-food items continue to register stronger price pressures.

0

2

4

6

8

10

12

14

16

18

2002 2003 2004 2005 2006 2007 2008

Headline Inflation Food Inflation Non-food Inflation

Headline, Food and Non-food Inflation Quarterly average in percent (2000=100)

Underlying price pressures increase in Q3 2008. Alternative Core Inflation MeasuresQuarterly averages of year-on-year change

Quarter TrimmedMean 1/

WeightedMedian 2/

Net of Volatile Items 3/ *

2006 5.4 5.0 6.9Q1 5.9 5.4 8.1Q2 5.8 5.0 7.6Q3 5.2 5.2 6.7Q4 4.5 4.2 5.0

2007 2.6 2.3 2.7Q1 2.9 2.5 3.0Q2 2.2 2.2 2.5Q3 2.3 2.1 2.5Q4 2.9 2.5 3.0

2008Q1 5.1 4.5 5.2Q2 7.7 7.4 8.0Q3 9.6 9.1 9.7

1/ 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.

* The series has been recomputed using a new methodology that is aligned with NSO’s 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: NSO, BSP estimates

Both food and non-food inflation in Q3 2008 were higher compared to the previous quarter and the year-ago levels. Inflation for food, beverages and tobacco (FBT) increased to 17.1 percent in Q3 2008 from 13.8 percent in Q2 2008 and 2.9 percent in the same quarter a year ago. Likewise, non-food inflation was higher at 7.8 percent relative to 6.1 percent in the last quarter and 2.2 percent in Q3 2007. Core inflation, an indicator of the long-term trend of inflation, continued to rise during the review quarter. The official NSO core inflation measure rose to 6.9 percent in Q3 2008 from 6.2 percent in the previous quarter and 2.9 percent in the same quarter in 2007. The alternative measures of core inflation estimated by the BSP all increased in Q3 2008. The trimmed mean went up to 9.6 percent from 7.7 percent in Q2 2008 and 2.3 percent in Q3 2007; the weighted median rose to 9.1 percent from 7.4 percent in the previous quarter and 2.1 percent in the same quarter a year ago; and the net of volatile items measure went up to 9.7 percent from 8.0 percent in the previous quarter and 2.5 percent in the comparable quarter in 2007.

5

Contribution to Quarterly Inflationin percent

Item Weight in Headline CPI

Percentage Contribution to Year-on-Year Headline

InflationQ3

2008Q2

2008Q3

2007Core Inflation 81.6 5.87 5.12 2.16Non-core Items 18.4 6.35 4.62 0.38

Rice 9.4 4.12 3.09 0.32Corn 0.9 0.29 0.24 0.04Fruits and Vegetables 5.3 0.81 0.54 0.09Gas, LPG 1.3 0.37 0.28 0.03Kerosene 0.3 0.13 0.07 -0.02Oil, Gasoline and Diesel 1.3 0.64 0.41 -0.08

Headline Inflation 100.00 12.23 9.75 2.54

Source of Basic Data: NSO, BSP

In terms of contribution to headline inflation, core inflation accounted for 5.9 percentage points of the headline inflation rate in Q3 2008, higher than the 5.1 percentage points in Q2 2008 and the 2.2 percentage points in the same quarter a year ago. Similarly, the contribution of non-core CPI items increased to 6.4 percentage points from 4.6 percentage points in the previous quarter; it was also higher than the 0.4 percentage point contribution recorded in the same quarter a year ago.

The number of items with above-target inflation rates increases.

0

20

40

60

80

100

120

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

2004 2005 2006 2007 2008

Cumulative Weight (in percent) Number of Items Exceeding Threshold Inflation

CPI Items with Inflation Above Threshold

Looking at the distribution of price changes in the CPI basket, it would also be useful to determine the proportion of CPI basket components (at the 4-digit Philippine Standard Industry Classification (PSIC) level) showing inflation rates above a given threshold and find out whether that proportion has been increasing or decreasing. This would provide an indication as to whether pressures on consumer prices are becoming generalized over time. Following higher inflation during the review period, the number of items with inflation rates greater than 5.0 percent (the upper end of the inflation target for 2008) increased to 96 in Q3 2008 from 80 in the previous quarter. Likewise, these items accounted for a bigger proportion of the CPI basket at 65.1 percent compared to 52.2 percent in the last quarter. Dividing the CPI basket into food and non-food components generated the same trend. There were 57 food items with inflation rates above-threshold compared to 51 in the previous quarter. Meanwhile, 39 non-food commodities posted inflation rates higher than the threshold in Q3 2008 compared to 29 in the previous quarter.

6

Inflation Rates for Selected Food ItemsQuarterly averages in percent (2000=100)

Commodity2008 2007

Q3 Q2 Q1 Q4 Q3

Food, Beverage and Tobacco 17.1 13.8 7.0 4.1 2.9Food 17.9 14.6 7.2 4.1 2.9Cereal & Cereal Products 36.7 28.0 8.6 6.0 3.5o/w Rice 44.0 33.0 8.7 7.0 3.4

Corn 33.0 27.0 5.9 2.7 4.3Dairy Products 13.7 13.5 11.4 7.6 5.5Eggs 6.1 7.9 8.1 7.6 7.6Fish 9.3 9.7 7.8 3.8 2.6Fruits & Vegetables 15.3 10.2 10.6 3.4 1.7Meat 10.9 10.5 4.9 2.6 3.1Misc. Food 9.1 7.4 4.2 2.5 1.9Beverages 6.1 5.1 3.7 2.7 2.9Tobacco 3.9 3.5 3.1 2.5 2.4

Source of Basic Data: NSO, BSP

Food Prices The dramatic rise in food inflation in the past two quarters was due largely to price increases in rice, meat, fish, fruits and vegetables, and miscellaneous food items. The increase in food prices accounted for 8.3 percentage points of the 12.2 percent headline inflation rate. In particular, rice, which constitutes 9.4 percent of the CPI basket, surged by 44.0 percent in Q3 2008 from 33.0 percent in the previous quarter. The rate of rice price increases peaked in July at 50.0 percent from 43.0 percent in June. Rice prices then decelerated to 45.1 percent in August and further to 37.3 percent in September. Declining world rice prices, early harvests, and government subsidy programs helped slow down rice price increases. The availability and increased usage of hybrid and high-yielding varieties (HYV)4 and fertilizer subsidies from the Ginintuang Masaganang Ani (GMA) Rice Program interventions have also contributed to the rise in palay output in agricultural production. The downtrend in rice prices is expected to continue in the coming months, with further production increases from sufficient water supply from rains and the restoration and rehabilitation of irrigation facilities, the availability of seed subsidy from the GMA Rice Program of the Department of Agriculture, and other intervention measures.

4 High-yielding varieties (HYVs) are any of a group of genetically enhanced cultivation of crops such as rice, maize and wheat that have an increased growth rate, an increased percentage of usable plant parts or an increased resistance against crop diseases.

Food prices continue to drive headline inflation.

7

Inflation Rates for Selected Non-Food ItemsQuarterly averages in percent (2000=100)

Commodity2008 2007

Q3 Q2 Q1 Q4 Q3Non-Food Items 7.8 6.1 4.2 2.6 2.2Clothing 4.6 4.1 3.1 1.8 2.1Housing & Repairs 4.9 4.1 2.7 1.2 1.3Fuel, Light & Water 7.1 8.0 5.4 2.8 4.2

Fuel 27.4 19.0 16.8 10.1 0.8Light -5.7 1.7 -1.8 -2.6 6.7Water 2.6 2.2 2.5 4.4 4.5

Services 12.7 8.2 5.9 4.3 2.1Transpo & Comm. 18.5 9.4 5.6 3.2 -1.1Miscellaneous 3.3 2.8 2.0 1.3 1.4

Source of Basic Data: NSO, BSP Oil prices hit record highs in July, but starts to retreat in September

5152535455565758595

105115

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Dubai Crude OilQuarterly average spot price in US dollars per barrel

Q3 2008 US$113.34

Non-Food Prices Non-food inflation continued to rise at 7.8 percent in Q3 from 6.1 percent in the previous quarter, with inflation dynamics appearing to have been higher in fuel and the transportation and communication sectors. Reflecting the record-high global oil prices in July, domestic pump prices of petroleum products were raised twice during the quarter. The inflation rate of services accelerated to 12.7 percent in Q3 2008 as against 8.2 percent in the previous quarter, and was considerably higher than the 2.1 percent registered in the same period last year, indicative of underlying price pressures. After peaking in July, global market conditions suggest that oil prices could be unwinding. Nevertheless, prices can be expected to remain elevated as market supply-demand balances remain tight. Meanwhile, all other non-food sub-components except for fuel, light, and water registered increases in their inflation rates during the quarter compared to the previous quarter. All sub-components saw higher inflation rates compared to the previous year. Energy Prices International oil prices were relatively generally lower in Q3 2008 compared to Q2 2008, reflecting falling demand for oil in the US due to sluggish economic growth. Based on a report from the US Energy Information Administration (EIA) in August, the demand for crude oil in the US recorded its steepest decline in 26 years (since 1982) as US economic growth slowed down in the first half of 2008. Easing prices were also influenced by concerns about weaker global demand for oil as economies around the world show signs of slower growth. The continuing turmoil in the global financial markets is expected to further weaken world demand, pulling down prices further. Dubai crude oil averaged US$113.34 per barrel in Q3 2008, lower by 3.1 percent compared to the previous quarter’s average of US$116.91 per barrel.

Likewise, higher fuel and transportation costs continue to push non-food inflation upwards.

8

Meanwhile, the Organization of Petroleum Exporting Countries (OPEC) decided during its 9 September 2008 meeting to reduce oil production by around half a million barrels a day. The OPEC believes that there is an oversupply in the market as the weaker world economic growth, particularly in the member countries of the Organization for Economic Cooperation and Development (OECD), has resulted in lower growth in the demand for oil. The EIA expects that OPEC will continue to lower its crude oil production over the next few quarters to prevent any sharp decline in prices.5 Both the EIA6 and OPEC7 cut their estimates for global oil demand for 2008 by 100,000 barrels per day. However, the EIA forewarned that the slowdown in oil demand growth will be temporary and that demand will recover. The EIA made a downward revision (by 130,000 barrels per day) in its projections for the third and fourth quarters of 2008, mainly reflecting the lower oil consumption from OECD countries. Meanwhile, emerging risks to the supply of crude oil, namely, the possible additional delays in key projects, heightened geopolitical risks affecting the Caspian export flows, expected hurricanes over the next few months, and potentially slower production in Russia, Mexico, and the North Sea, may dampen non-OPEC supply growth. This could, in turn, lead to both higher demand for OPEC oil and higher prices compared to EIA’s current projections.

9

Local pump prices of oil products are lower in Q3 2008.

6

16

26

36

46

56

66

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Premium Gasoline Diesel Oil

Local Retail Prices of Selected Oil ProductsPrice in pesos per liter

Sep 2008P48.94

Sep 2008P50.57

World oil prices are expected to soften.

10

30

50

70

90

110

130

150

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Spot and Estimated Future Prices of Dubai Crude Oil* Price in US dollars per barrel

*Futures price derived using Brent crude futures data.

30 Sep 08

28 Dec 07

30 Jun 08

Power rates decrease in Q3.

In the domestic market, the pump prices of kerosene and diesel oil fell by P3.50 per liter each, gasoline products dropped by P9.50 per liter, and LPG by P1.56 per liter in end-Q3 2008 compared to the end of Q2 2008. The prices of gasoline products and diesel oil were reduced ten times while the prices of kerosene and LPG declined nine and four times, respectively, during the review quarter. The import tariff on specific crude and refined petroleum products remained at zero in the third quarter.8 [The import tariff on specific crude and refined petroleum products was increased to 1 percent in October.] The estimated future prices of Dubai crude oil, based on movements in Brent crude oil futures, suggest lower prices for Q4 2008 largely driven by expectations of weaker global demand for oil. Utility Charges Power Electricity rates went down in the third quarter due to lower National Power Corporation (NPC) rates. On June 2008, the Energy Regulatory

10

Electricity Rates

-15.0

-10.0

-5.0

0.0

5.0

10.0

2007 Q1 2007 Q2 2007 Q3 2007 Q4 2008 Q1 2008 Q2 2008 Q3

perc

ent c

hang

e (%

)Meralco Rates (y/y)Ave NPC Rates (y/y)CPI Light (y/y)

Commission (ERC) provisionally ordered the NPC to reduce rates in Luzon by P0.71/kilowatt-hour (kwh) and in Mindanao by P0.02/kwh. The adjustments pertain to the NPC’s Deferred Accounting Adjustment (DAA) applications on the following: (1) incremental fuel and independent power producer (IPP) costs under the Generation Rate Adjustment Mechanism (the 9th GRAM); and (2) Exchange rate-based cost fluctuations under the Incremental Currency Exchange Rate Adjustment (the 8th ICERA). With the six-month recovery period under the approved 9th GRAM and 8th ICERA, electricity rates are expected to remain stable until November 2008. However, there are additional upside pressures on electricity rates stemming from the NPC’s pending petitions with the ERC.9 These include the NPC’s petition to increase the basic rate for Luzon by P0.37/kwh. According to the NPC, the rate adjustment is necessary since its remaining plants run on bunker and fuel oil and are more expensive to operate. The NPC has also filed for the 10th GRAM and 9th ICERA adjustments. If approved, this will increase rates in Luzon and Visayas by P0.18/kwh and P0.45/kwh, respectively. Rates in Mindanao, however, will go down by P0.36/kwh. To mitigate the impact of the proposed adjustments, the NPC applied for a recovery period of 16 months. Volatility in the wholesale electricity spot market (WESM) could add to price pressures. There are also pressures on electricity rates stemming from Meralco’s pending petitions of with the ERC. These include the petition to retrieve lifeline and inter-class cross-subsidy under-recoveries, increase the distribution charge starting this year under the performance-based rate (PBR) application, and collect P5-billion worth of transmission charges which it paid in advance to the National Transmission Corporation (Transco). On other industry developments, the ERC has ordered distribution utilities (DUs) to refund customer meter deposits. The DUs collected meter deposits until 2004 when it was discontinued upon the order of the ERC. For the Meralco franchise area, the refund will start in November 2008.

11

PSALM bids out 14 power plants, accounting for 60 percent of the capacity target set to be completed in 2009. Water rates are higher in Q3. On the telecommunications sector, the NTC pushes for lower interconnection charges to bring down the cost of short message service (SMS) and voice calls.

The ERC also set for public consultation the draft resolution that will lower system loss caps for DUs. The resolution provides for the electricity consumption of a DU to be treated as an expense and not as part of system loss, and lowers the maximum recoverable rate of system loss from 9.5 percent to 8.0 percent for private DUs and from 14.0 percent to 11.0 percent for rural electric cooperatives (ECs), based on the total kwh generated, purchased and distributed. The existing system loss caps have not been adjusted since 1999 (nine years) for DUs and 2000 (eight years) for ECs. PSALM has now sold 14 out of the 31 NPC plants identified for privatization as it successfully bid out the 289-MW Tiwi Geothermal Power Plant located in Albay and the 458.53-MW MakBan Geothermal Power Plant in Laguna and Batangas.10 This translated to 2,597.93 MW operating capacity, or 60.0 percent of the 4,336 MW aggregate capacity target set for bidding up to 2009. Water The Metropolitan Waterworks and Sewerage System-Regulatory Office (MWSS-RO) approved a lower discount under the foreign currency differential adjustments (FCDA) for Q3 2008. This translated to a slight increase in water rates for both Manila Water and Maynilad by 1.1 and 0.9 percent, respectively, in the third quarter relative to the previous quarter. However, on a year-on-year basis, Maynilad water rates are still lower by 2.9 percent while the rates of Manila Water are higher by 20.2 percent.11 The lower FCDA discount was due to the depreciation of the peso from March to May 2008. Telecommunications12 The National Telecommunications Commission (NTC) drafted a memorandum circular that will lower interconnection charges13 between networks. Once implemented, this will limit access charges in short message service (SMS) to not more than P0.15 and put a cap of P1.50 per minute for cellular calls. The existing access charge for SMS is P0.35 per text message and P4.00 per minute for voice calls between separate cellular networks. The NTC is also revisiting its pending proposal to lower interconnection charges for calls using the voice over internet protocol (VOIP) technology.

12

The NTC earlier proposed a rule which would peg the access rate of VOIP calls at P1.50 per minute. This proposal has been drafted early this year. However, discussions during the period in review were focused mainly on the new proposal to impose a ceiling on access charges on SMS and voice calls via mobile phones.

Aggregate Demand and Supply

5 EIA Short-Term Energy Outlook, 9 September 2008, www.eia.doe.gov 6 Oil Market Report, 10 September 2008, www.iea.org 7 Monthly Oil Market Report, September 2008, www.opec.org 8 Under the implementing guidelines, the tariff on imported oil products will be reduced from 3 percent to between 0-2 percent when oil prices reach the (revenue neutral) trigger price levels indicated by the DOF. The trigger period shall be based on the first 15 days of the month when the average price of oil shall be computed for purposes of determining the trigger prices. If the trigger price levels are reached, the DOE shall issue a certification to DOF for the latter to implement the corresponding reduction in oil import tariff. 9 As of 2007, NPC accounts for 70 percent of gross power generation in the country. 10The 14 power plants that have been sold are Tolomo, Agusan, Barit, Cawayan, Loboc, Pantabangan-Masiway, Magat, Masinloc, Calaca, Ambuklao-Binga, and Tiwi-Makban. 11 The difference in the direction of water rates is due to the rate rebasing of the Manila Water Company, Inc (MWCI). According to the MWCI, the rate rebasing was necessary to recover capital expenses in the next 15 years. Rate rebasing is a process done by the MWSS every five years to review the service improvement plan and evaluate the required capital investment to implement the plan. This is the second time the MWSS and the Manila Water have undertaken this exercise; the first one was in 2002. 12Communications comprise 1.92 percent of the CPI basket. 13 Interconnection charges are fees paid by a carrier for every minute of call that passes through the network of another carrier.

13

The economy grows at a slower pace.

-3

-1

1

3

5

7

9

2002 2003 2004 2005 2006 2007 2008

GDP GNP

GDP and GNP Growth RatesAnnual Growth in Real Terms

Economic growth moderated in the second quarter of 2008. Real Gross Domestic Product (GDP) rose by 4.6 percent from 8.3 percent in the same period last year. On the expenditure side, the growth of household spending and capital formation slowed down while government consumption contracted, which was attributed to a high base following last year’s spending on pump-priming activities. Meanwhile, total exports accelerated in the second quarter, led by the expansion in non-merchandise exports. On the production side, agriculture, fishery and forestry grew faster relative to last quarter and last year, while industry grew faster than the previous quarter but slower than last year. Services decelerated relative to both periods. During the review period, real GNP growth also moderated to 5.5 percent from 9.8 percent in the second quarter of last year as the continued inflow of remittances from overseas workers was offset by a decline in property income (specifically interest income from investment in bonds and deposits abroad). Nonetheless, net factor income from abroad (NFIA) remained strong, growing at a double-digit rate of 14.1 percent during the quarter. Seasonally-adjusted GDP growth accelerated to 2.0 percent in Q2 2008 from 0.3 percent in the previous quarter on account of the robust performance of the industry and agriculture, fishery and forestry (AFF) sectors.

Aggregate Demand Expenditures (by major economic sectors) The growth of personal consumption

14

-25-20-15-10-505

1015202530

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Govt. Spending Private Consumption Fixed Investment

Domestic DemandAnnual Growth in Real Terms

Economic PerformanceGrowth rate (in percent)

Sector 2008 2007Q2 Q1 Q2

By expenditure itemPersonal consumption 3.4 5.2 5.6Government Consumption -5.1 1.9 11.9Capital Formation 14.7 4.0 17.6

Fixed Capital Formation 5.6 2.9 20.9Exports 7.7 -6.1 4.9Imports -1.0 -5.8 -10.5

Source: NSCB

expenditure (PCE) moderated to 3.4 percent in the second quarter of 2008 from 5.6 percent a year ago as high commodity prices constrained spending. Food expenditure, which comprises over half of total PCE, slowed to 2.7 percent growth from 6.1 percent a year ago. All other PCE subsectors slowed except for household furnishings, which grew by 13.5 percent from a decline of -1.0 percent a year ago. Expenditure on transportation and communication decelerated to 8.0 percent from 9.6 percent; clothing and footwear as well as tobacco also showed weaker growth. Fuel, light and water on the other hand, declined by 1.8 percent from its 6.0 percent contraction of the previous year, while beverages declined by 0.7 percent from a 3.2 percent growth in the same period. Government consumption expenditure (GCE) contracted by 5.1 percent in the same month of the second quarter of 2008 after expanding by 11.9 percent in the same quarter last year. The decline can be attributed to a high base following last year’s spending on pump-priming activities. The growth of gross capital formation remained in double-digit at 14.7 percent, although lower than the 17.6 percent growth registered in the comparable period in the previous year due to the slowdown in public construction. Private construction, however, surged by 25.0 percent from the previous year due to the strong demand for mid-income housing supported by better financing schemes and the low interest rate environment. Meanwhile, exports accelerated by 7.7 percent during the second quarter of 2008 from 4.9 percent last year, led by non-merchandise exports, reflecting the upsurge in the IT-enabled services/BPOs in the country. Total imports posted a lower decline of 1.0 percent compared to the 10.5 percent decline in the same period last year, as non-merchandise imports grew by 21.6 percent. Likewise, merchandise imports posted a lower drop of 2.5 percent from a decline of 11.6 percent in the previous year.

15

Imports of Goods (BOP data)Growth rate (in percent)

Commodity Group2008 2007

Q2 Q1 Q2

Capital Goods 6.3 4.6 3.9

Raw Materials & Intermediate Goods

2.5 -0.6 2.7

Mineral Fuels & Lubricant

43.6 85.5 8.0

Consumer Goods 62.5 52.4 26.7

Special Transactions 24.4 5.6 -42.2

Total Imports1/ 15.2 14.7 4.5

Conceptual and coverage adjustments

56.3 1840.0 -223.1

Total Imports, BPM5 15.5 15.4 5.8

1/ Include valuation adjustments to NSO dataSource: BSP

Imports Based on the Balance of Payments (BOP) data, imports of goods rose by 15.5 percent year-on-year for Q2 2008, an acceleration from both the year-ago and quarter-ago levels.14 All major commodity groups posted positive year-on-year increments during the review quarter. The import value of mineral fuels and lubricants rose significantly by 43.6 percent due to higher prices of petroleum crude. Import of consumer goods also posted a marked increase of 62.5 percent, led by the rising cost of rice and strong demand for passenger cars and motorized vehicles. In terms of contribution to growth, mineral fuels, lubricants and related materials accounted for 7.3 percentage points. This was followed by imports of consumer goods, which contributed 5.1 percentage points.

14 Merchandise imports in the quarterly BOP report are quoted in current US dollar prices, while those from the NIA are quoted in constant 1985 peso prices. Imports per BOP are based on the BPM5 concept (i.e., excluding from the NSO foreign trade figures those goods that did not involve change in ownership) and reflect, among others, the following things: a) upward adjustments on the valuation of consigned raw materials for electronics and garments exports; b) OF remittances in kind; and c) military imports. Based on the Q2 2008 NIA, merchandise imports based on constant 1985 peso prices declined by ___ percent in Q2, following a___ percent drop in Q1 and a___ percent increase in Q2 2007.

16

*Base year chosen was the earliest year for which data was available

Other Demand Indicators Other indicators seem to suggest a moderation in demand conditions: 1) energy sales declined; 2) property prices show moderate increases and 3) business and consumer confidence declined. Meanwhile, vehicle and appliance sales accelerated. Property Prices • Latest estimates from Colliers International

Research showed that land values in Q2 2008 rose by 25.3 percent year-on-year for the Makati Central Business District (CBD) and 12.1 percent year-on-year for Ortigas Center. Quarter-on-quarter, the estimated land values in the Makati CBD and the Ortigas areas were slightly higher by 0.6 percent and 0.3 percent, respectively. Colliers expects land values to appreciate further by 3.0 percent for Ortigas Center and 5.0 percent for the Makati CBD for the whole year of 2008. Land values were about 67-70 percent of their 1997 levels in nominal terms, but only about 36-37 percent of their 1997 levels in real terms.

Vacancy Rates, Makati CBD (%)

2008 2007

Forecast Year-On-Year Growth (%)

2008 2009Q2 Q1 Q2 Q3* Q4* Q1* Q2

Office 1.6 2.7 3.4 3.9 2.6 2.0 2.5

Residential (all grades) 5.3 8.4 7.1 6.5 6.5 9.7 4.4Source: Colliers International Research* Forecast f rom previous quarterly reports.

Vacancy Rates • Office and residential vacancy rates in the

Makati CBD at 1.6 percent and 5.3 percent, respectively, were lower in Q2 2008 compared to the previous quarter and year-ago levels. For 2008, Colliers projects the office vacancy rate to remain at around 1.5 percent to 2.5 percent despite additions to stock. For residential space, Colliers projects the vacancy rate to remain at around 4.0 percent to 5.0 percent for the rest of the year. For Q2 2009, Colliers expects the average office vacancy rate to settle at about 2.5 percent, while the residential vacancy rate is projected to reach about 4.4 percent.

*Average Land Values, Makati CBD and OrtigasReal prices, based on CPI (1991=100)(in pesos per square meter)

0

50,000

100,000 150,000

200,000

250,000

300,000

1998 2001 2002 2003 2004 2005 2006 2007

Makati Ortigas

17

Rental Values

• Office rents in the Makati CBD increased by

9.5 percent year-on-year in Q2 2008 to an average of P808/sq.m. 15 According to Colliers, rental rates have yet to reach peak levels, but rental escalation is expected to moderate for the rest of the year at 7.0 percent. Rents may slightly correct in early 2009 before resuming escalation up to the end of the year.

• Rents for three-bedroom condominium

units in the Makati CBD rose by 9.1 percent year-on-year in Q2 2008 to P566/sq.m., a slowdown relative to the 20.7 percent increase in 2007. The full-year rental rate increase is expected to be lower at 10.0 percent compared to 15.0 percent last year due to mounting supply pressure. For 2009, growth is expected to narrow to less than 2.0 percent with the increase in supply, both in the CBDs and alternative locations.

• Office rental values continued to rise in Q2

2008, breaching the 1997 levels for premium grade offices. In real terms, however, office rental values are only about 60.0 percent of the comparable levels in 1997.

• Colliers also reported that residential rents

in Rockwell and Fort Bonifacio as of Q2 2008 rose year-on-year by 6.8 percent to P664/sq.m. and 5.4 percent to P589/sq.m, respectively. Colliers expects residential rents in Rockwell to improve further in 2008 to achieve a 10.0 percent growth year-on-year as no new supply is expected. Meanwhile, Fort Bonifacio residential rents are expected to slow down to 4.0 percent in 2008 and 1.0 percent in 2009 due to the influx of new supply and alternatives.

15 This was computed as the average of the rental values for the Premium, Grade A and Grade B segments. Premium refers to office space with capital values of P75,000/sq.m. and above; Grade A, between P65,000 and P75,000/sq.m.; and Grade B, P65,000/sq.m. and below.

Office and Residential Rental Values Real prices, based on CPI (1995=100)(in pesos per square meter per month)

0 100 200 300 400 500 600 700 800 900

1,000

1998 2001 2002 2003 2004 2005 2006 2007

Office rental value Residential rental value

18

-100

-50

0

50

100

150

200

2003 2004 2005 2006 2007 2008Passenger Cars Commercial Vehicles

Sales of Passenger Cars and Commercial VehiclesYear-on-year change in percent

-80

-60

-40

-20

0

20

40

60

80

100

120

140

2003 2004 2005 2006 2007 2008

Sales of Trucks and BusesYear-on-year change in percent

Vehicle Sales • Vehicle sales, except commercial vehicles,

posted a robust growth in the third quarter based on the July-September data of the Chamber of Automotive Manufacturers of the Philippines, Inc. (CAMPI).

• Passenger car sales in Q3 2008 surged by 20.7 percent year-on-year, compared to 13.0 percent and 5.0 percent in Q2 2008 and Q3 2007, respectively. According to CAMPI, this was due to a shift in consumer preference to vehicles with smaller engine displacement in view of the elevated prices of petroleum products, as well as promotional offers and fleet account sales. Year-to-date sales likewise grew at a higher pace of 14.0 percent from 5.6 percent in the same period last year.

• Similarly, sales of trucks and buses for Q3

2008 registered a growth of 11.8 percent year-on-year, a slowdown from the 14.7 percent growth in the previous quarter, but a turnaround from the 2.7 percent rise in Q3 2007. This was due to the increase in the fleet account sales in July. However, year-to-date sales growth decelerated to 8.2 percent from a 24.0 percent growth rate recorded in January-September 2007.

• Meanwhile, due to a shift in preference

towards passenger cars, sales of commercial vehicles slowed down markedly at 2.3 percent year-on-year in Q3 2008 from 22.4 percent a year ago. Likewise, year-to-date commercial vehicle sales growth decelerated to 11.0 percent from 23.5 percent in the comparable period a year ago.

19

-10

-5

0

5

10

15

2000 2001 2002 2003 2004 2005 2006 2007 2008

Meralco Power SalesYear-on-year change in percent

-60

-50

-40

-30

-20

-10

0

10

20

30

40

J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J

Appliance SalesYear-on-year change in percent

2006 2007 2008

Power Sales • Energy sales by Meralco declined by 1.3

percent year-on-year in July 2008. This was a reversal of the 6.7 percent expansion in the comparable period last year and the 6.4 percent growth in the first month of the previous quarter. The continued decline in sales to the residential sector coupled with the slower growth of sales to the commercial sector offset the increase registered by the other sectors. The slowdown in electricity consumption was also evident in Q2 as growth of energy sales slowed down to 1.6 percent relative to the 4.6 percent in Q2 2007. Year-to-date sales grew at a slower pace of 1.4 percent from the 4.6 percent growth registered in January-July of the previous year.

Appliance Sales • Appliance sales continued to surge for the

second consecutive month, growing by 34.9 percent year-on-year in July 2008, a turnaround from the 3.8 percent decline recorded in the same period a year ago. This could be an initial indicator of a better performance in Q3. Appliance sales in Q2 2008 posted a lower growth of 6.3 percent compared to 9.0 percent in Q2 2007. Year-to-date, appliance sales grew strongly at 12.3 percent from 8.9 percent in the same period a year ago.

78.0

78.5

79.0

79.5

80.0

80.5

81.0

81.5

82.0

2007 2008

Average Capacity Utilization for ManufacturingIn percent

• Based on the NSO’s Monthly Integrated Survey of Selected Industries (MISSI), average capacity utilization in manufacturing showed a gradual uptrend starting January this year, to reach an average of 80.8 percent in Q2 2008 from 80.3 percent in the previous quarter.

20

-15

-10

-5

0

5

10

15

2007 2008

Volume of Production Value of Production

Volume and Value Indices of Manufacturing Productionyear-on-year change in percent

• On a quarterly basis, the average growth

rate of the value of production index (VAPI) in Q2 2008 rose to 9.4 percent, a turnaround from the year- and quarter-ago average growth rates of negative 5.2 percent and negative 0.4 percent, respectively.

• Similarly, the quarterly average growth rate

of the volume of production index (VOPI) rose to 6.9 percent in Q2 2008, a significant improvement from the 0.4 percent decline in the previous quarter. This was also higher than the 6.8 percent contraction in the same period last year.

Business sentiment weakens.

Business Expectations SurveyIndex 2008 2007

Q3 Q2 Q1 Q3 Q2

Business Outlook Index

Current Quarter -12.9 12.6 29.9 40.9 46.4

Next Quarter 16.6 16.6 41.0 53.0 44.7

Source: BSP

Business Expectations Survey • Business confidence turned negative at -

12.9 percent, the first since Q3 2005. This indicated that respondents with a negative outlook outnumbered those with a positive outlook. This sentiment is consistent with the broadly pessimistic outlook of businesses and consumers in many developed countries. The index was lower by 25.5 index points and 53.8 index points compared to the previous quarter and the year-ago levels, respectively.

• The negative index in Q3 reflected the

outlook of respondent firms being weighed down by the following factors: 1) the unabated increase in crude oil prices and other raw materials; 2) the rising domestic prices of food (especially rice) and services (transportation and communication); 3) the global economic downturn, particularly in the US, the country’s major trading partner; 4) the increase in wages; and 5) local political noise. More respondents, however, were optimistic that business conditions would improve in Q4 2008, in anticipation of a pick-up in consumer demand and the influx of remittances from overseas Filipinos in time for the Yuletide season.

• The business outlook for Q4 2008 at 16.6

percent was unchanged quarter-on-quarter but lower by 36.4 points year-on-year.

21

Consumer confidence declines further. Consumer Expectations SurveyIndex 2008 2007

Q3 Q2 Q1 Q3 Q2

Current Quarter -52.8 -43.8 -32.1 -23.6 -26.0

Next 3 months -25.1 -26.9 -3.4 4.1 -6.7

Next 12 months -23.9 -20.3 6.6 7.9 5.8

Source: BSP

Consumer Expectations Survey • The nationwide consumer confidence index

(CI) for Q3 2008 slid further quarter-on-quarter by 9.0 index points and 29.2 index points year-on-year to negative 52.8 percent.16 Similar declines were reflected by the CI’s three component indices on the current economic and family conditions. Among the reasons cited for the weaker outlook were the rising prices of fuel and basic commodities, the anticipated increase in the number of unemployed, and the reduced household income.

Exports increase.

Exports of Goods (BOP data)Growth rate (in percent)

Commodity Group2008 2007

Q2 Q2

Coconut products 68.9 10.5

Sugar and Products -7.1 -18.7

Fruits and Vegetables -3.9 4.7

Other Agro-based products 26.2 6.4

Forest products 37.5 35.8

Mineral products -0.8 36.3

Petroleum products 1.3 44.1

Manufactures 3.7 2.9

Special transactions 27.2 -20.4

Total Exports, as per NSO Foreign Trade Statistics

5.3 4.6

Conceptual and coverage adjustments -16.3 22.9

Total Exports, BPM5 5.2 5.1

Source: BSP

External Demand Exports of goods17 went up by 5.2 percent in Q2 2008, generally steady relative to the 5.1 percent growth in the same period in 2007 but much higher than the 3.0 percent growth in the previous quarter.18 More than half of the expansion came from manufactures which contributed 3.2 percentage points to total export growth for the period. These were mainly other electronics, processed food and beverages, and machinery and transport equipment. Coconut products also contributed significantly to export growth (1.4 percentage points), with coconut oil contributing the bulk at 1.3 percentage points, boosted mainly by the high price of commodities in the world market.

16 The overall consumer outlook index is determined by the outcome of 3 measures, namely, outlook on macroeconomic condition, family financial situation and family income. 17 Based on BPM5 concept [i.e., excluding from the NSO foreign trade figures those goods that did not involve change in ownership such as goods exported for exhibit purposes and equipment previously imported for use in manufacturing and eventually re-exported to mother companies abroad (temporary exports)]. 18 Based on the Q2 2008 NIA, merchandise exports based on constant 1985 peso prices increased by 5.5 percent in Q2 following the 11.0 percent decline in Q1 and 6.3 percent increase in Q2 2007.

22

Major production sectors—with the exception of agriculture—slow down.

Economic PerformanceGrowth rate (in percent)

Sector 2008 2007Q2 Q1 Q2

By industrial originAgriculture, Fishery & Forestry 4.9 2.7 4.2

Agriculture and Fishery 4.9 2.7 4.3Forestry -1.6 2.4 -8.4

Industry 4.8 3.0 10.3Mining and quarrying -18.5 14.1 38.9Manufacturing 6.1 2.4 3.4Construction 8.3 -3.4 37.0Electricity, gas and water 7.9 9.5 5.4

Services 4.3 6.5 8.4Transport., Comm., & Storage 3.3 5.6 9.6Trade 4.3 5.8 7.6Finance 2.4 12.2 14.2O. Dwellings & real estate 7.3 7.3 6.0Private services 6.2 5.7 9.1Government services 2.4 4.0 2.4

Source: NSCB

Aggregate Supply On the production side, the services sector registered a slower growth of 4.3 percent from 6.5 percent in Q1 2008 and 8.4 percent in Q2 2007. This sector, which represented about 46.0 percent of total GDP, contributed 2.1 percentage points to the 4.6 percent GDP growth for the review period, significantly lower than its contribution to the quarter- and year- ago GDP growth rate. The slowdown may be attributed to the adverse impact of the rising cost of fuel and other basic commodities. The slowdown was particularly evident in the marked deceleration in transportation, communications, and storage (TCS), trade, finance, and private services. Meanwhile, demand for residential space from OFs and for commercial space from the business process outsourcing (BPO) industry fueled the growth in the real estate sector. Other dwellings and real estate (ODRE) was the only sector among the services sub-group which accelerated in the second quarter. The agriculture, fishery and forestry (AFF) sector expanded by 4.9 percent during the second quarter of 2008, compared to 4.2 percent in Q2 2007 and 2.7 percent in Q1 2008. Growth in the AFF sector was propelled by palay, corn, banana and sugarcane. The growth in palay was attributed to the increase in the harvested area due to sufficient water supply from rains and the restoration and rehabilitation of irrigation facilities. The major gainers in agriculture also included corn, coconut, and banana. Coconut continued to benefit from the higher price of copra since 2007. Meanwhile, growth in the industry sector was slower at 4.8 percent in Q2 2008 relative to 3.0 percent in the previous quarter and 10.3 percent in Q2 2007. The contraction in mining and quarrying and the sharp deceleration in the construction sub-sectors affected the industry sector adversely.

23

Labor Market Conditions Unemployment and underemployment rates decline.

0.0

5.0

10.0

15.0

20.0

25.0

30.0

6.0

6.5

7.0

7.5

8.0

8.5

9.0

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3

2006 2007 2008Unemployment rate, SA Underemployment

Unemployment and Underemployment Rate

Based on the results of the July 2008 Labor Force Survey (LFS), the unemployment rate declined to 7.4 percent in July 2008 from its year-ago level of 7.8 percent.19 There were 34.6 million Filipinos employed in July out of approximately 37.3 million in the labor force. Total employment rose by 3.8 percent year-on-year. The services sector employed 50.2 percent of the total employed population, while the agriculture and industry sectors accounted for 35.0 percent and 14.8 percent, respectively. The underemployment rate likewise fell to 21.0 percent in July 2008 from 22.0 percent in the same period last year. Underemployed persons in agriculture accounted for 46.9 percent, services, 38.2 percent, and industry, 14.9 percent.20

19 Starting April 2005, the new LFS questionnaire defines the unemployed to “include all persons who were 15 years old and over as of their last birthday and were reported as without work, and currently available for work, seeking work or not seeking work for valid reasons.” 20 Underemployed 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. Invisible underemployment refers to individuals who are working in jobs where their skills are not adequately utilized (e.g. nursing graduate working as a bank teller).

24

II. MONETARY AND FINANCIAL CONDITIONS

Interest Rates

2

4

6

8

10

12

14

16

18

20

2000 2001 2002 2003 2004 2005 2006 2007 2008

91-day T-bill rate Overnight RRP Rate Bank Lending Rate (Low-end)

91-day T-bill rate, BSP RRP rate and KBs Lending RateIn percent

The T-bill rates averaged higher across all maturities during the quarter. The benchmark 91-day T-bill rate rose to 5.699 percent from 3.673 percent in Q2 2008. Similarly, the 182-day and 364-day T-bill rates were higher at 6.480 percent and 6.849 percent from 4.670 percent and 5.384 percent in the same period, respectively. Treasury bills remained attractive to investors as auctions by the Bureau of the Treasury (BTr) continued to draw a large volume of bids in Q3 2008, with average monthly subscriptions during the quarter at P6.5 billion, exceeding the P2.4 billion recorded in Q2 2008. Meanwhile, the average bank lending rate rose to 8.7 percent in Q3 2008 from 8.3 percent (revised) in the previous quarter.

2

3

4

5

6

7

8

9

10

11

12

3Mo 6Mo 1Yr 2Yr 3 Yr 4Yr 5Yr 7Yr 10Yr 20Yr 25Yr

Yiel

d in

per

cent

Maturity

end March 2008 end-June 2008 end-September 2008

Yield of Government Securities in the Secondary MarketIn percent

Yield Curve Secondary market yields generally declined by end-September 2008 except for the 3-month, 6-month, and 1-year tenors compared to end-June 2008 levels. The decrease in the yields ranged from 57.5 basis points (2-year GS) to 128.8 basis points (10-year GS). The yield curve shifted downward, as heightened concerns about the worsening global and U.S. financial turmoil which, in turn, led to a “flight to quality” sentiment among domestic investors.

Domestic interest rates rise.

Yields in the secondary market decline.

25

-400.00

-300.00

-200.00

-100.00

0.00

100.00

200.00

300.00

400.00

500.00

Mar 06 Jun 06 Sep 06 Dec 06 Mar 07 Jun 07 Sep 07 Dec 07 Mar 08 Jun 08 Sep 08

91-day T-bill vs US 90-day LIBOR (before tax) 91-day T-bill vs US 90-day T-bill (before tax)

91-day T-bill vs US 90-day LIBOR (after tax) 91-day T-bill vs US 90-day T-bill (after tax)

Interest Rate Differentialsin basis points

0

1

2

3

4

5

6

7

8

2004 2005 2006 2007 2008

BSP RRP rate US Fed funds rate

BSP RRP Rate and US Fed Funds Rate In percent

Interest Rate Differentials The positive differentials between domestic and US T-bill rates, net of tax, widened as of end-September with the rise in domestic interest rates. Similarly, the after-tax differentials between domestic interest rates and the US LIBOR widened compared with the level as of end-June 2008. The differential between the BSP's policy interest rate (overnight borrowing or RRP rate) and the US federal funds target rate widened from 325 basis points in Q2 2008 to 400 basis points in Q3 2008, reflecting the net effect of the BSP's policy rate increase of 75 basis points during the quarter. Adjusted for the risk premium—which is measured by the differential between the 10-year Republic of the Philippines (ROP) note and the 10-year US Treasury note—the positive differential between the BSP’s policy rate and the US federal funds target rate widened to 96 basis points as of end-September 2008 compared to 28 basis points as of end-June 2008. The rise in interest rate differentials could potentially attract foreign exchange inflows.

Real lending rates remain negative.

-3.00

0.20

-1.30

2.30

1.30

-2.20

2.20

1.30

2.00

0.80

-4 -3 -2 -1 0 1 2 3 4

Philippines

Japan

Singapore

Hong Kong

Thailand

Malaysia

South Korea

Taiwan

India

Indonesia

Average Real Lending Rates: Selected Asian CountriesIn percent

The real lending rate—measured as the difference between the median bank lending rate and inflation—remained in negative territory at -3.0 percent in Q3 2008 compared to -3.2 percent in the previous quarter, due mainly to higher inflation in Q3 2008. The Philippines’ real lending rate remained the lowest in Q3 2008 in a sample of 10 Asian countries.

Interest rate differentials between Philippine and US rates continue to widen.

26

Financial Market Conditions

Trading in the local bourse was sluggish during the third quarter due to continued concerns over the global financial turmoil. Meanwhile, ample liquidity in the market sustained the appetite for government debt instruments. Stock Market  

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2000 2001 2002 2003 2004 2005 2006 2007 2008

PSE Composite Index

Trading in the local equities market continued to weaken during the third quarter of 2008 with the Philippine Stock Exchange Composite Index (PSEi) averaging (using monthly closing averages) 2,611.6 index points from the previous quarter’s 2,679.1 index points. Investors in the local stock market remained cautious on account of the continued weakening of the US financial markets. The stock market slightly recovered in August on positive sentiment due to the support of the Fed and the US Treasury to the financial sector, coupled with the drop in oil prices following the decline in the global demand for oil. However, the market plunged in September due to external shocks with the collapse of the Lehman Brothers, the sale of Merrill Lynch & Co. to Bank of America, and the US Fed’s takeover of the American International Group, Inc. (AIG).21 As of end-September, the market succumbed to grave external pressures as it plunged to its year-to-date low of 2,831.65 index points. Government Securities

Ample liquidity in the financial system continued to help channel investible funds into the government securities market as the primary market continued to attract strong bids in the third quarter of 2008. Total oversubscriptions for the third quarter rose threefold to reach P39.2 billion from the P14.2 billion posted in the second quarter of 2008. The eighteen regular T-bill auctions in the third quarter drew a total of P75.2 billion tenders against a total offered amount of P36 billion.

Financial market sentiment remains weak amid worsening global financial developments.

Strains in global financial markets weigh down investor enthusiasm in the local bourse.

T-bill oversubscriptions increase further.

0

20

40

60

80

00

20

40

2000 2001 2002 2003 2004 2005 2006 2007 2008

Oversubscription of T-bill AuctionsIn billion pesos

27

Debt spreads widen amid the worsening global financial market turbulence.

Sovereign Bonds and CDS Spreads As the Lehman Brothers’ collapse triggered a significant spike in risk aversion against emerging market assets, the risk of holding Philippine bonds increased. Debt spreads widened further in Q3 2008 relative to the Q2 2008 levels. In particular, the cost of protecting the country’s bonds against default rose with the Philippine five-year credit default swap (CDS)22 spread widening to 283.1 basis points as of end-September from the end-June level of 265 basis points.23 During the same period, the spread of ROP 2015 bonds over the benchmark 10-year US Treasury notes also widened to 390 basis points as of end-September from 286 basis points in end-June.

28

Banking System

Philippine banking system remains stable. The Philippine banking industry continued to perform well during the third quarter and its overall condition remained sound and stable. A summary of key performance indicators showed the banking system’s resilience in spite of persistent concerns over the recent financial meltdown on Wall Street. The reforms instituted in the past years strengthened the industry in terms of capital buildup, enhanced risk management, and adherence to good governance. Bank lending expanded, bank asset quality improved, and banks remained adequately capitalized.

Banks’ deposit base increases.

Savings Mobilization The banking system’s total deposit liabilities as of end-February 200824 was broadly unchanged at P3.5 trillion compared to its level a year ago. Demand deposits grew by 7.7 percent year-on-year, while savings deposits, which continued to account for half of the banks’ funding base, registered a modest 0.8 percent growth. However, time deposits declined by 3.5 percent from a year ago. Compared to the previous quarter, the banking system’s deposit liabilities declined by 1.8 percent.

Growth in consumer loans remains strong.

Lending Operations Consumption loans also accelerated to 20.2 percent in August, driven mainly by the expansion in credit card receivables. The combined credit card receivables (CCRs) of U/KBs and thrift banks (TBs) including their credit card subsidiaries, increased by 19.7 percent year-on-year as of end-March 2008 to reach P115.4 billion, but minimally declined by 0.6 percent compared to the P116.1 billion posted at end-December 2007. The ratio of CCRs to the total loan portfolio (TLP) at 5.4 percent was higher than last year’s 5.0 percent, but slightly lower than the 5.5 percent recorded during the previous quarter. Of the total CCRs, 10.2 percent was past due, an improvement from the 14.2 percent recorded at end-December 2007. Similarly, U/KBs’ and TBs’ combined auto loans (ALs), inclusive of their non-bank subsidiaries’

29

loans, declined by 1.0 percent as of end-March 2008 to P73.9 billion from P74.7 billion level in the same period last year, and by 14.2 percent from the end-December 2007 level of P86.2 billion. The decline in ALs stemmed from the change in financial reporting under the new system of bank reporting.25 ALs accounted for 3.5 percent of TLP, lower than the 3.9 percent in the same period last year and 4.0 percent at end-December 2007. The non-performing ALs to total ALs ratio rose to 5.7 percent from 5.1 percent in the same period last year and at end-December 2007. U/KBs' real estate loans (RELs) as of end-December 2007 declined slightly by 0.6 percent to P197.7 billion from its year-ago level of P198.9 billion but increased modestly by 2.7 percent compared to the previous quarter’s level of P192.6 billion, resulting in a lower ratio of RELs to TLP at 10.4 percent from the previous year’s 11.5 percent and the previous quarter’s 11.2 percent. The majority or 97.2 percent of total RELs was held by U/KBs’ bank proper, while the remaining 2.8 percent was on the account of U/KBs’ trust departments. RELs extended for the construction and development of real estate properties for commercial purposes, including infrastructure projects, comprised the bulk of property loans at 79.9 percent while the balance of 20.1 percent was granted for the acquisition of residential units by individual homeowners/borrowers.

Resources of the banking system expand.

Institutional Developments The total resources of the banking system rose by 7.3 percent to P5.4 trillion as of end-May 2008 from its year-ago level of P5.0 trillion. The increase was due mainly to the rise in the cash and loans accounts. U/KBs continued to account for almost 90 percent of the total resources of the banking system.

30

The number of banking institutions (head offices) fell further to 841 as of June 2008 from the year-ago level of 858, reflecting the continued consolidation of banks as well as the exit of weaker players in the banking system. By banking classification, banks (head offices) consisted of 38 U/KBs, 80 TBs, and 723 rural banks (RBs). Meanwhile, the operating network (including branches) of the banking system increased to 7,769 from 7,738 during the same period last year, reflecting mainly the increase in commercial and rural banks’ branches/agencies. On a quarterly basis, the number of banking institutions was also lower than the 845 registered as of the end of the previous quarter. The banking system’s asset quality continued to improve, as the non-performing loan (NPL) ratio eased further to 4.5 percent as of end-June 2008 compared to 5.7 percent a year ago. The improvement in the NPL ratio during the period was due to the 8.1 percent drop in the level of NPLs, complemented by the 17.1 percent expansion in the industry’s TLP. NPLs declined to P124.5 billion during the period under review from the previous year’s level of P135.4 billion, while TLP expanded to P2,772.6 billion from P2,367.2 billion during the same period last year. Meanwhile, the NPL ratio of U/KBs fell further to 4.0 percent as of end-June 2008, an improvement from 5.2 percent a year ago. Compared with other countries in the region, the Philippine banking system’s NPL ratio of 4.5 percent was higher than Indonesia’s 4.0 percent, Malaysia’s 2.5 percent, Thailand’s 4.1 percent, and South Korea’s 0.7 percent.26 The lower NPL ratios in Malaysia, Thailand, and South Korea may be traced to the creation of publicly-owned asset management companies (AMCs), which purchased the bulk of their NPLs, a practice which was not resorted to in the Philippines. The loan exposure of banks remained adequately covered as the banking system’s NPL coverage ratio was steady at 83.9 percent as of end-June 2008, reflecting banks’ diligent compliance with the loan-loss provisioning requirements of the BSP to ensure adequate buffers against unexpected losses. The banking system remained adequately capitalized as of end-December 2007 with the

Number of banks falls due to mergers and consolidations but operating network continues to expand.

Asset quality of banks continues to improve.

Banks remain adequately capitalized.

31

average capital adequacy ratios (CARs) remaining strong at 14.7 percent on a solo basis and 15.7 percent on a consolidated basis. Both were higher than the BSP’s 10.0 percent required minimum ratio. The stricter requirements of Basel 2 caused the decline in the CARs of the banking system as compared with last year’s CARs of 16.9 percent and 18.1 percent on solo and consolidated bases, respectively. The Philippine banking system’s CAR remained comparatively higher than those of Malaysia (13.2 percent), and South Korea (12.0 percent) but lower than Thailand (19.3 percent) and Indonesia (17.6 percent). 27  Meanwhile, special deposit account (SDA) placements rose by P42.3 billion to P503.7 billion as of 22 September 2008 from P461.4 billion as of end-September 2007. The higher level of SDAs could be attributed to the liquidity management measures implemented by the BSP, which allowed trust entities of BSP-supervised financial institutions to make placements in the SDA facility. Meanwhile, the total volume of banks’ placements with the BSP under the RRP window amounted to P193.9 billion during the same period, lower than the end-September 2007 level by P12.1 billion.

32

Exchange Rate

35

40

45

50

55

60

2000 2001 2002 2003 2004 2005 2006 2007 2008

P/US$

Daily Peso-US Dollar Rate

  

Changes in Selected Dollar Rates

Appr./Depr. (-)Year-to-date

30 Sep 08 30 Jun 08

Philippine peso -12.3 -8.1

Thai baht (offshore) 11.8 -10.4

Chinese yuan 6.7 6.5

Malaysian ringgit -3.2 1.6South Korean won -22.4 -10.5 Singaporean dollar 1.4 6.4 New Taiwan dollar 1.0 7.1 Indonesian rupiah -0.2 2.0 Japanese yen 7.2 6.6 Indian Rupee -15.1 -8.2

 

The peso depreciated by 5.5 percent quarter-on-quarter to average P45.51/US$1 in the third quarter of 2008.28 Nonetheless, on a year-on-year basis, the peso slightly appreciated by 1.0 percent. The peso continued to weaken during the review period as risk aversion rose further on concerns of a slowing global economy, particularly in the Euro area, as well as the worsening financial turmoil caused by the U.S. sub-prime mortgage crisis. The strengthening of the US dollar due to the sharp decline in global commodity and oil prices also weighed down on the peso. The depreciation of the peso was partly tempered by the strong dollar inflow of OF remittances. The peso weakened from July up to September, reaching P47.26/US$1 on 30 September amid heightened risk aversion on concerns over the worsening U.S. financial market turmoil and the country’s weaker trade position. The peso and other regional currencies weakened as risk aversion rose after Lehman Brothers Holdings, Inc. filed for bankruptcy protection and Merrill Lynch was acquired by Bank of America Corporation on 15 September 2008. Moreover, the downgrade of the credit ratings of the AIG, Inc. by Standard & Poor’s and Moody’s added to market jitters. Asian currencies recovered slightly as investors bought back regional stocks after the U.S. Federal Reserve’s $85 billion rescue of AIG on 16 September 2008 eased fears of a financial system meltdown. However, emerging markets’ assets came under pressure following the delay in the passage of the $700 billion financial rescue plan to purchase distressed assets of U.S. financial institutions.29

The peso weakens.

33

.

On a year-to-date basis, the peso depreciated against the U.S. dollar by 12.3 percent on 30 September 2008, as investors shunned emerging markets’ assets.30 Other currencies that depreciated against the US dollar were the Thai baht, Korean won, Malaysian ringgit, Indonesian rupiah, and Indian rupee. Meanwhile, other selected Asian currencies maintained their strength against the US dollar, led by the Chinese yuan’s 6.7 percent appreciation. Volatility, as measured by the coefficient of variation of the daily average exchange rates, was slightly lower at 2.2 percent in the third quarter relative to 2.5 percent in the previous quarter despite the peso’s depreciation. On a real, trade-weighted basis, the peso gained some external price competitiveness in the third quarter, relative to the previous quarter, against the baskets of currencies of major trading partners (MTPs) and competitor countries.31 The real effective exchange rate (REER) index of the peso decreased by 0.2 percent quarter-on-quarter against the basket of currencies of MTPs and by 0.7 percent and 1.8 percent against the baskets of currencies of competitor countries in the broad and narrow series. 32 The relatively larger nominal depreciation of the peso during the quarter negated the widening of the inflation differential against competitor countries and translated to the decrease in the REER index of the peso against these baskets of currencies. However, on a year-on-year basis, the peso lost some external price competitiveness in the second quarter as the REER index of the peso increased by 3.7 percent, 6.3 percent and 3.1 percent against the baskets of currencies of MTPs and competitor countries in the broad and narrow series, respectively.

34

Monetary Aggregates

Domestic liquidity or M3 accelerated in August, expanding by 9.8 percent year-on-year from 5.1 percent in June. This was based on the new system of bank reports that is consistent with the International Accounting Standards (IAS) and International Financial Reporting System (IFRS). The expansion in domestic liquidity was driven by the strong growth in net domestic assets (NDA) at 10.0 percent from 1.5 percent in June. This can be traced mainly to the sustained expansion in credits extended to the private sector, supported by the strong bank lending growth during the period. Meanwhile, credit extended to the public sector continued its declining trend, as the buildup in the deposits of the National Government (NG) with banks more than offset the increased lending to the NG and to local governments and other public entities. The expansion in net foreign assets of depository corporations slowed down to 5.4 percent (from the 17.7 percent growth registered in June), influenced largely by the decline in the foreign assets of depository corporations as banks’ investments in foreign securities during the month were lower relative to the same period a year ago. Year-on-year growth in reserve money, a narrower measure of monetary aggregates, declined to 10.9 percent as of end-September 2008 from 11.6 percent as of end-June 2008.33

Liquidity expands further.

35

Based on preliminary data obtained from the new system of bank reporting, outstanding loans of universal and commercial banks (U/KBs) including reverse repurchase agreements or RRPs, climbed to 24.1 percent year-on-year as of end-August, from the 10.6 percent expansion posted in end-June. Loans for production activities, which accounted for the bulk of total outstanding loans, led the expansion, growing by 19.8 percent in August. The following production sectors contributed significantly to lending growth: wholesale and retail trade (which grew by 54.0 percent); transportation, storage and communication (94.2 percent); electricity, gas, and water (65.8 percent); agriculture, hunting, and forestry (19.2 percent); manufacturing (8.3 percent); and real estate, renting, and business services (13.8 percent).

Growth in bank lending continues.

36

The fiscal deficit reached P53.4 billion for the period January-September, higher than last year’s P40.0 billion deficit for the same period. Revenue collections grew by 8.3 percent to P879.9 billion compared to P812.3 billion for the same period last year. Of this amount, the Bureau of Internal Revenue (BIR) and the Bureau of Customs (BOC) contributed P587.9 billion and P193.2 billion, as their collections grew by 12.6 percent and 26.3 percent, respectively, compared to the same levels as the period last year. On the other hand, revenue collections from the BTr declined by 13.7 percent to P47.8 billion from P55.3 billion in the comparable period last year. Revenues from other offices also went down to P51.1 billion. Meanwhile, the cumulative expenditures for January-September 2008 amounted to P933.3 billion, 9.5 percent higher than the comparable disbursements in 2007. Excluding interest payments, total disbursements increased by 11.0 percent to P698.6 billion. Interest payments also rose by 5.4 percent to reach P234.7 billion.

Fiscal Developments The fiscal deficit for the first nine months of 2008 is higher than year-ago levels.

National Government Fiscal PerformanceJanuary- September 2008In billion pesos

January-September (%)Change2008 2007

Surplus/(Deficit) -53.4 -40.0 -33.4

Revenues 879.9 812.3 8.3

Expenditures 933.3 852.3 9.5

Source: BTR

37

III. External Developments Global economic conditions deteriorates rapidly amid one of the most severe global financial crisis in decades.

Indicators point to a US recession in 2008 and early 2009 despite Q2 2008 growth.

The global economy is facing its most difficult challenge in many years as it continues to be hit by the combination of an imminent economic slowdown, still elevated inflation levels, and the most widespread financial turmoil in decades. Many analysts observed that inflation may be nearing its peak in developed and emerging market countries, but the challenge remains for monetary policymakers to keep the effects of food and energy price shocks already in the pipeline from seeping further into core inflation and inflation expectations. More recently, the failure of some of the major financial institutions in the US sent ripples of massive market sell-offs worldwide. Going forward, the US financial market upheaval may stunt global demand as a credit crunch resonates through the global economy, as liquidity for financing dries up and becomes more expensive. US GDP quarter-on-quarter growth recorded a relatively stronger pace of 2.8 percent in Q2 2008, from its 0.9 percent growth in Q1, reflecting primarily a larger decrease in imports and an acceleration in exports and the stimulus package that took effect in Q2.34 However, available data for Q3 suggest a slowdown and forward-looking indicators indicate that the economy likely contracted in Q3. The housing market continues to be the primary source of weakness in the real economy as well as in the financial markets. The slowdown in economic activity has spread outside the housing sector as negative feedback loops have set in. The unemployment rate jumped to 6.1 percent in August from 5.7 percent in July and non-farm payroll employment continued to trend downward in the same month.35 In addition, vehicle sales declined sharply in August, reflecting a broad-based decreased in consumer spending despite the efforts of the US government to pump-prime demand through its fiscal stimulus package.36 Meanwhile, overall household consumption and retail sales have picked up, but this may be due to the seasonal summer consumption spending in July.

38

The Euro area outlook deteriorated sharply towards the end of Q2 2008. Q2 GDP declined quarter-on-quarter by 0.2 percent compared to the 0.7 percent growth in Q1 2008. On a year-on-year basis, GDP growth was positive at 1.5 percent but is still lower compared to the 2.1 percent growth in the same period last year.37 The Euro area’s weakness is likely to persist going forward as signaled by the steady decline in leading indicators such as the Purchasing Managers’ Index for manufacturing and services. Meanwhile, inflation seems to have peaked at 4.0 percent in July, and have in fact started to recede in August at 3.8 percent.38 Q2 2008 GDP in Japan grew year-on-year at a more moderate pace of 1.0 percent, compared to the 1.2 percent growth in Q1 2008. Analysts noted that the Japanese economy appears to have entered a cyclical downswing, reflecting the slowing global demand. The slowdown is even more pronounced on a quarter-on-quarter basis, with GDP declining by 0.6 percent versus the 0.8 percent growth in Q1 2008. The Japanese economy is expected to weaken further in the coming quarters, given the slowdown in the global economy and the softening of the Japanese labor market.39 China’s real GDP growth has been decelerating in the past four quarters, from 12.6 percent year-on-year in Q2 2007, to 10.1 percent in Q2 2008. On the inflation front, price pressures have been easing steadily since April 2008 and worries of an even sharper post-Olympic slowdown prompted the Chinese government to shift its policy focus from inflation to growth. This can be seen from the direction of its monetary policy stance, which has been on a gradual loosening path. In particular, the People’s Bank of China (PBC) increased its lending quotas by 5 to 10 percent in July, and the appreciation of the Chinese yuan was slowed. In addition, there have been no hikes in the reserve requirement ratio since June 2008.40

Meanwhile, growth is falling sharply in the Euro area, while inflation also seems to have peaked.

The headwinds from high commodity prices seem to be receding in Japan, but the downside risks remain high.

Concerns in most Asian countries shifts from inflation to growth.

39

Although increases in food and energy prices may subside in the coming months, IMF expects inflation in emerging Asia to remain at elevated levels over the near term.

Growth has also weakened in India, as Q2 2008 GDP grew by a slower rate of 7.9 percent year-on-year from 8.8 percent in the previous quarter. The slower growth was due mainly to rising borrowing and input costs, declining consumer purchasing power, and the weakening of external demand. For India, however, high inflation has been a challenge in 2008, as inflation has been accelerating sharply since February, and reached double-digit levels in June. The Reserve Bank of India (RBI) has expressed in its monetary policy statements its concern on rising inflation expectations and second-round effects.41 Monetary policy responses to high inflation rates that peaked in July and August have varied across the region. India, Indonesia, Korea, Philippines, Thailand, Taiwan, and Vietnam tightened policy rates, China and India increased reserve requirements, and Singapore supported an appreciation in the exchange rate band. Following the rapid deterioration in global financial markets which became pronounced in September, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, Sveriges Riksbank, and the Swiss National Bank announced reductions in their respective policy interest rates.42

The major central banks also took account of the firm evidence that pointed to a weakening of economic activity and a reduction in inflationary pressures.

Central banks around the world adopt an easing bias in view of the financial market turmoil and its impact on economic growth.

40

IV. Monetary Policy Developments

4

5

6

7

8

9

10

11

2002 2003 2004 2005 2006 2007 2008

Overnight RRP Rate Overnight RP Rate

BSP Policy Interest RatesIn percent

BSP forecasts in the early part of the quarter show that price pressures have intensified even as they are projected to ease starting late 2008.

During its 17 July meeting, the Monetary Board increased the BSP’s key policy interest rates by 50 basis points to 5.75 percent for the overnight borrowing or reverse repurchase (RRP) facility and 7.75 percent for the overnight lending or repurchase (RP) facility. The interest rates on term RRPs, RPs, and special deposit accounts (SDAs) were also raised accordingly. The Monetary Board recognized that inflation control is the foremost priority of the BSP, in accordance with its mandate. The Monetary Board, in its assessment of price conditions, noted as well that concurrent and interrelated shocks to the economy—such as the persistent surge in oil prices and spikes in commodity prices—have contributed to elevated inflation readings. Second-round effects were evident early in the quarter, as reflected in the wage and transport fare increases and in rising inflation expectations. The Monetary Board considered the BSP's baseline forecasts which showed the risk of inflation exceeding the inflation targets for 2008 and 2009. Price pressures have increased even as they were projected to ease starting late 2008. For this reason, authorities believed that more decisive monetary action was necessary. Sustained high inflation could unseat inflation expectations and potentially create a repeating cycle of lingering inflation and wage pressures that could prove costly to the economy. By responding promptly to inflation risks, the BSP intended to reduce the risks to inflation expectations and the long-term cost to output growth from prolonged high inflation. Authorities believed that the series of policy adjustments will help to steer inflation towards its desired path for the medium term.

The BSP raises its policy rates further during the third quarter, mindful that inflation control is its foremost priority.

41

In August, further monetary tightening was deemed necessary to stabilize inflation within the target range. At the same time, the Monetary Board notes that the emerging inflation outlook reflected the recent easing in global food and oil prices.

In its subsequent meeting on 28 August, the Monetary Board decided to increase the BSP’s key policy interest rates by another 25 basis points to 6.0 percent for the overnight borrowing or RRP facility and 8.0 percent for the overnight lending or RP facility. The interest rates on term RRPs, RPs, and SDAs were adjusted accordingly. In its assessment, the Monetary Board recognized that further measured tightening of monetary policy was necessary given the latest forecasts which indicated above-target inflation for both 2008 and 2009. Monetary policy should be appropriately tight to stabilize inflation to within the target range over the policy horizon, and to help manage inflation expectations. Moreover, fluctuations in international oil prices continued to pose a major risk to the inflation outlook. Nevertheless, the declining trend in commodity prices should help moderate inflation pressures. Going forward, the Monetary Board stressed that it will continue to keep a watchful eye on the balance of risks to the BSP’s price stability objective with a view to implementing appropriate policy actions.

42

V. INFLATION OUTLOOK Private Sector Economists’ Inflation Forecasts

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

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

AP Consensus Survey of Inflation ForecastsMonthly, In percent

2008

2009

2008 2009

56.9

29.5

0.0

10.0

20.0

30.0

40.0

50.0

60.0

<0 1.0-2.0 2.1-3.0 3.1-4.0 4.1-5.0 5.1-6.0 6.1-7.0 7.1-8.0 8.1-9.0 9.1-10.0 10.1-11 11.1-12 >12

2008 2009

Probability Distribution For Analysts' Inflation Forecasts* 2008 and 2009

*Probability distributions were averages of those provided by 11 respondents. (Source: BSP Survey)

Private Sector Forecasts for Inflation Annual Percent Change

Q4 Full year Q1 Full yearATR Kim Eng Securities 11.0 10.0 9.5 6.0Banco de Oro 12.5 9.6 11.0 8.6Bank of America 9.7 9.2 8.1 5.0Bank of the Philippine Islands 10.0 9.8 8.5-9.5 6.0-7.0Citibank 11.3 9.7 9.9 6.5Deutsche Bank 10.9 9.6 8.7 7.0Economist Intelligence Unit 11.4 9.7 9.0 7.0FORECAST Pte Ltd 12.0 10.0 10.1 6.4HSBC 10.3 9.2 7.3 5.9IDEA 12.8 10.1 12.4 10.0ING Bank 11.0-11.6 9.6-9.8 9.3 6.4Metrobank - 10.0 - -Nomura Securities Co., Ltd. 11.0 9.7 8.5 6.7Philippine Equity Partners 10.9 9.7 9.6 6.6RCBC 11.6 9.8 9.9 5.7Standard Chartered Bank 9.5 9.3 6.4 3.2

Median Forecast 11.0 9.7 9.3 6.5Mean Forecast 11.1 9.7 9.2 6.5High 12.8 10.1 12.4 10.0Low 9.5 9.2 6.4 3.2Number of observations 15 16 15 15

2008 2009

Based on the BSP’s survey, Q3 2008 inflation forecasts showed higher inflation expectations for both 2008 and 2009.43 The mean inflation forecast for 2008 at 9.7 percent was higher than the previous quarter’s 8.8 percent. Lingering inflation was expected to continue to affect the average price level in 2008. Higher inflation expectations were largely driven by fuel and food prices during the first half of the year. The weaker peso, which drives upward the costs of imported products, also added to the price pressures. Meanwhile, some analysts reported that inflation may have already peaked and pressures had somehow subsided recently. The softening of commodity prices, especially energy, due to the slowdown in global demand, was expected to support the decline in inflation. At the same time, weaker consumer spending would likely keep demand pressures on a downward path. For 2009, the survey also showed a higher mean inflation forecast of 6.5 percent compared to the previous quarter’s 6.1 percent. The mean inflation forecast of analysts is 11.1 percent for Q4 2008 and 9.2 percent for Q1 2009. Based on the probability distribution of respondents’ forecasts, there is a 56.9 percent chance that average inflation for 2008 will fall within 9.1-10.0 percent, above the 4.0 percent (±1.0 percentage point) target for 2008. The Asia Pacific Consensus Forecasts44

for Philippine inflation in 2008 and 2009 showed rising expectations in July and August, but yielded lower inflation expectations in September 2008 relative to the previous month.

Private sector forecasts are higher for 2008 and 2009, although the forecast curve appears to be flattening

43

BSP Inflation Forecasts

The BSP’s baseline forecasts indicate that inflation will likely settle above the 2008 and 2009 targets. However, future inflation is expected to decelerate to single-digit levels in 2009 to reach the target-consistent path by 2010.

The current inflation outlook continues to show that inflation could settle above the inflation targets for 2008 and 2009 targets. The inflation forecasts for 2008 and 2009 declined due to the lower-than-projected inflation outturns for September 2008, the easing in prices of oil and non-oil commodities in the world market, and for 2009, some base year effects from high inflation in 2008. The emerging baseline forecasts show that inflation will unwind over the next few months, decelerating to single-digit levels in 2009, to reach the target-consistent path by 2010. Demand Conditions Domestic demand conditions moderated during the quarter in review. GDP growth for Q2 slowed down, reflecting the adverse impact of higher commodity prices—which constrained consumption spending—as well as the slowdown in global growth. Consumer confidence and business outlook weakened based on the third quarter survey. Most demand indicators showed some cooling down: declining energy sales, easing demand for energy-related and -intensive goods, and generally moderating increases of land and rental values in the property sector. Supply Conditions On the supply side, recent developments suggest that some of the factors driving the current surge in oil and non-oil commodity prices appear to be unwinding. The favorable outlook on food production amid expectations of production increases, favorable weather conditions and higher market prices as well as the government’s multi-pronged intervention programs to improve agricultural production are expected to provide a favorable influence on the outlook for prices.

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Output Gap Estimates The balance of demand and supply conditions, as captured by the output gap (or the difference between actual and potential output) provides an indication of potential inflationary pressures in the near term. Inflation tends to rise (fall) when demand for goods and services exert pressure on the economy’s ability to produce goods and services, i.e., when the output gap is positive (negative). Based on revised GDP data, preliminary estimates yielded an output gap of 4.2 percent in Q2 2008, which was higher than the previous quarter estimate. The positive output gap could indicate demand pressures that may contribute to higher inflation. Inflation Expectations Concerns about second-round effects remain despite the recent easing of international commodity prices, as domestic price pressures will likely persist for some time as a result of the continuing feed-through of past commodity price increases. Relative to the previous survey, results of the BSP’s latest survey among private sector economists and analysts indicate higher inflation expectations for both 2008 and 2009. However, the rise in inflation expectations is lower in Q3 2008 from Q2 2008 compared to the rise in Q2 2008 from Q1 2008. Inflation expectations for 2008 based on the Q3 2008 survey was 9.7 percent compared to 8.8 percent in Q2 2008 and 4.9 percent in Q1 2008. Meanwhile, inflation expectations for 2009 based on the Q3 2008 survey was 6.5 percent compared to 6.1 percent in Q2 2008 and 4.2 percent in Q1 2008. Higher inflation expectations were also evident in the third quarter Consumer Expectations Survey (CES) and Business Expectations Survey (BES) with a higher number of respondents anticipating an increase in the prices of goods and services over the next twelve months. Nonetheless, the stabilization of oil and rice prices will help cement inflation expectations going forward.

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Key Assumptions used to generate the BSP’s Inflation Forecasts The BSP’s baseline inflation forecasts indicate that inflation will slow down over the policy horizon. The forecasts are generated from the BSP’s single equation model (SEM) and the multi-equation model (MEM), and are based on the following assumptions: (a) endogenously-determined real GDP growth in the BSP multi-equation model; (b) a budget deficit of 1.0 percent of GDP for 2008 and 0.5 percent of GDP for 2009; (c) headline overnight RRP rate of 6.0 percent starting October 2008; (d) 91-day T-bill rate which is consistent with the DBCC-approved macroeconomic assumptions and the Dubai crude oil price assumption which is consistent with the futures price of oil in the international market; (e) increase in nominal wage of 6.5 percent in June 2009; and (f) endogenously-determined exchange rate in the BSP’s Multi-Equation model through purchasing power parity and interest parity relationships.

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Risks to the Inflation Outlook The latest fan chart shows a lower central projection, as inflation slowed down in September and the expected futures prices of oil declined. However, upside risks surrounding the inflation outlook remains.

The risks to the inflation outlook over the policy horizon may be presented graphically through a fan chart. The fan chart depicts the probability of different inflation outcomes based on the central projection (corresponding to the baseline forecast of the BSP) and the risks surrounding the inflation outlook. The current fan chart represents a slight decreasing inflation path relative to that of the previous quarter, particularly in the second year of the policy horizon which spans two years. The central projection is expected to decelerate in Q1 to Q3 of 2009 due partly to base year effects of high inflation during the same period of 2008 as well as lower-than-projected inflation outturns for September 2008 and the easing in the prices of oil and other non-oil commodities in the world market. This outlook is subject to some uncertainty as depicted by the widening bands of the fan chart over time. Risks to the inflation outlook appear to be more balanced relative to the previous quarter. The main upside risks to the inflation outlook consist of the volatility in oil prices; the weakening of the peso against the US dollar; and possible increases in utility rates. On the other hand, there are downside risks which could come from a sharper-than-anticipated downtrend in commodity prices and the dampening impact of the global economic slowdown on aggregate domestic demand.

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Latest Inflation Profile

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

Year-on-Year Inflation

20102008 20092007

The fan chart shows the probability of various outcomes for inflation over the forecast horizon. The darkest band depicts the central projection, which corresponds to the BSP’s baseline inflation forecast. It covers 25 percent of the probability. Each successive pair of bands is drawn to cover a further 25 percent of probability, until 75 percent of the probability distribution is covered. The bands widen (i.e. “fan out”) as the time frame is extended, indicating increasing uncertainty about outcomes. The band in wire mesh depicts the inflation profile as of Q2 2008.

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The negative impact of a slowdown in the global economy on demand for oil will help ease the pressures from world oil prices. Prevailing projections for global and domestic agricultural production are favorable, indicating an easing in food prices going forward.

The estimated path of futures prices for Dubai crude has been shifting downwards, given expectations of weak global demand. Downside risks to oil prices also include a sharper-than-expected deceleration in oil demand growth due to the lagged impact of high oil prices. In its latest report, the EIA revised downward its demand growth projections for the third and fourth quarters of 2008, mainly reflecting weaker oil consumption by OECD countries.45 Likewise, the International Energy Agency (IEA) revised downward its demand growth estimates for 2008 and 2009.46 Meanwhile, the downtrend in oil prices has served to temper additional transport fare increases. Bus and jeep operators deferred their fare increase petitions while a consumer group has filed a petition for reductions in minimum fares in Metro Manila. The FAO forecasts world cereal production in 2008 to increase by 2.8 percent. This is expected to help improve the global supply and demand balance for cereals in the near term. The expected strong increase in global wheat production, higher wheat export supplies, and the recent decline in maize and crude oil prices are likely to continue to put downward pressure on global wheat prices. In the coarse grains sector, expectations of higher maize production in South Africa, the decline in crude oil and soybean prices, prospects of very large supplies of low-quality wheat,47 and improved crop conditions in the United States have contributed to the decline in maize prices in the futures market. On domestic production, palay output for July-December is expected to be higher than the year-ago level, due to prospects of sufficient water supply from rains and rehabilitated irrigation facilities, greater availability of seed subsidy, and other intervention measures on agricultural modernization and food security.

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Meanwhile, inflationary pressures could come from the volatility in oil prices, and possible increases in utility rates.

Oil consumption in emerging market economies continues to grow and uncertainties over expansion in non-OPEC supply due to potential delays in key projects persist. The EIA also noted that OPEC crude oil production in 2009 could be lower than the 2008 levels. On 9 September 2008, the OPEC announced it will comply with its September 2007 production quotas, a move which would translate to about 500,000 barrels per day reduction in output. These factors will keep oil prices volatile over the near term. There are possible sources of increases in electricity rates in the near term. These include: (1) the depreciating peso; (2) the NPC’s petition to increase Luzon basic rates due to high operating expenses; (3) the NPC’s petition for the 10th GRAM and 9th ICERA; (4) Meralco’s petition to retrieve under-recoveries from lifeline and inter-class cross subsidies; (5) the increase in Meralco’s distribution charge under the performance-based rate application; (6) higher transmission charges related to Meralco’s petition to recover advances made to TransCo; (7) The Meralco’s petition to recover typhoon-related losses incurred in 2006; and (8) the readjustment in the WESM settlement price following the Court of Appeals decision to deny the petition of PEMC for a temporary restraining order on the ERC ruling on the WESM price manipulation issue.

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VI. IMPLICATIONS FOR THE MONETARY POLICY STANCE

The outlook for inflation indicates a deceleration in inflation. Price pressures are no longer demand-driven, and early signs of steady/improving inflation expectations are emerging. Nevertheless, possible sources of upside risks to inflation remain.

The emerging forecast indicates that inflation will decelerate over the next few quarters and could likely be in the single-digit levels by the second quarter next year (2009). With the full effects of the earlier increases in policy rates yet to be felt, future headline inflation is expected to decelerate towards the target-consistent path by 2010. Price pressures, which were linked partly to supply side factors driving global commodity prices, have abated. Food price increases have slowed down given favorable output conditions in both domestic and international markets while oil prices have plummeted on a weakened economic outlook. This implies that the risk of a spill-over to domestic prices that will trigger another series of second-round effects is reduced. Demand conditions in the first semester have been weaker as the growth of household spending slowed down to its lowest pace since 2001. Moreover, the absence of new wage-increase petitions and the decision of the transport groups to defer their request for fare increase are seen to reduce demand-side price pressures. While the results of the BSP’s Q3 2008 survey on inflation forecasts showed higher inflation expectations for 2008 and 2009, the rise in inflation expectations are nonetheless lower in Q3 2008 from Q2 2008 compared to the rise in Q2 2008 from Q1 2008. Meanwhile, the latest Asia Pacific Consensus Forecasts for Philippine inflation showed lower inflation expectations for 2009. A general decline in secondary yields and the narrowing of term spreads have likewise been observed. Moreover, the stabilization of oil and rice prices is also expected to help cement inflation expectations. The volatility in world oil prices due to structural factors, the depreciation of the peso (which is currently exerting upward pressure on, for example, utility rates as well as on imported commodities), and the modest build-up of domestic liquidity are the major risks to the inflation outlook. The positive output gap is another potential signal of demand-based inflationary pressures that are in the

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Monetary authorities are mindful of the implications of the global financial crisis on the continued efficient functioning of the financial system which serves as the main channel of transmission of monetary policy. Price stability retains primacy, but financial system stability is also a key objective.

pipeline. With the protracted nature of the current elevated inflation trend, real interest rates may remain in negative territory until late this year, running the risk of creating additional upside pressures on inflation as negative real interest rates are indicative of accommodative monetary conditions. Meanwhile, second-round effects of the recent price surge will likely continue for some time. Second-round effects are still present as seen in the unabated increase in non-food inflation, particularly in the services components. The price pressures reflected in the higher NSO- and BSP-generated core inflation measures also suggest possible lingering demand-side pressures. Nonetheless, the softening of demand should provide a countervailing influence. There are also no indications that second-round effects are increasing as of end-September given the absence of new wage and transport fare petitions and the early signs of improving inflation expectations. Monetary policy will remain geared towards the achievement of price stability while exercising flexibility given the presence of significant shocks to the real sector. The current challenge is to combine the right degree of flexibility in the inflation targeting framework with sufficient confidence that the inflation rate would be on a declining path. Likewise, it is worth emphasizing that the BSP’s objectives of promoting price stability and financial market stability are mutually reinforcing as the efficient functioning of the financial system, will, in turn, ensure the effective functioning of the transmission channels for monetary policy. In this situation of heightened tension, the BSP is firm in its resolve to undertake policy actions that will ensure the soundness and the stability of the banking sector and to strengthen the public’s trust and confidence in the financial system, by making sure that there is no credit gridlock or a freezing-up of credit markets and at the same time provide sufficient liquidity to fund the growth requirements of the economy.

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[Subsequently, on 6 October, the Monetary Board maintained the BSP’s key policy interest rates for the overnight borrowing or reverse repurchase facility at 6.00 percent and 8.00 percent for the overnight lending or repurchase facility. On 17 October, the Monetary Board approved the opening of a US dollar repurchase agreement facility to augment dollar liquidity in the market and is expected to support the orderly functioning of the financial system, which is an effective channel of monetary policy.]

The BSP Inflation Report is published every quarter by the Bangko Sentral ng Pilipinas. The report is available as a complete document in pdf format, together with other general information about inflation targeting and the monetary policy of the BSP, on the BSP’s website:

www.bsp.gov.ph/monetary/inflation.asp If you wish to receive an electronic copy of the latest BSP Inflation Report, please send an e-mail to bspmail@bsp.gov.ph. The BSP also welcomes feedback from readers on the contents of the Inflation Report as well as suggestions on how to improve the presentation. Please send comments and suggestions to the following addresses:

By post: BSP Inflation Report

c/o Department of Economic Research Bangko Sentral ng Pilipinas

A. Mabini Street, Malate, Manila Philippines 1004

By e-mail: bspmail@bsp.gov.ph