Philippine central bank shifts to variable rate repo auction

The Philippine central bank has changed how it operates its overnight reverse repurchase (RRP) facility, its key monetary policy tool.

It said on September 4 that it would shift its RRP auctions to a variable rate format with a predetermined offer size starting today (September 8). Previously, the Bangko Sentral ng Pilipinas used a fixed rate format.

In an RRP operation, the BSP sells government securities to banks and selected non-banks with a commitment to buy them back on a specified future date at a predetermined rate. Banks’ payment to the BSP reduces liquidity in the financial system.

Under the new mode of auction, the BSP will announce an offer size based on its forecasts of excess liquidity in the financial system. Participating financial institutions will submit bids for both the amount of funds and their interest rates, with the BSP deciding which bids are successful.

Previously, financial institutions received interest at the BSP policy rate. Up until July 13, the BSP typically offered to absorb 305 billion pesos ($5.38 billion) daily via the RPP facility, central bank data shows.

The BSP said the changes are part of its planned reforms dating back to the adoption of the interest rate corridor framework in 2016. It said these are largely operational in nature and do not constitute any shift in its monetary policy stance.

New operational target

The BSP said the changes will help improve monetary policy transmission and strengthen the price discovery process. It will provide market participants and monetary authorities with a market-determined interest rate based on demand for and supply of overnight funds.

This market-determined rate for overnight funds is called the “Overnight (ON) RRP Rate”, which conveys the results of the daily RRP auctions, the BSP said. The ON RRP rate also serves as the BSP’s new “operational target”.

This operational target will provide monetary authorities with an important market-based indicator for them to assess “the effective stance of monetary policy”, the BSP said.

The ON RRP rate is distinct from the BSP’s key policy rate, which is now renamed the “Target RRP Rate”. The central bank held the benchmark interest rate unchanged at 6.25% in August for the third meeting in succession, after raising it by a cumulative 425bp since May to curb inflation.

The Philippines’ headline inflation ticked up to 5.3% year-on-year in August, up from 4.7% in July, as rice and fuel prices surged. It exceeded the central bank’s inflation target range of 2-4% for 2023.

The BSP said the ON RRP is expected to move closely around the Target RRP Rate. The two rates may diverge from time to time due to changes in liquidity, but the central bank said it will adjust the auction size depending on demand so that the market rate will move in line with the policy rate over time.

The central bank absorbed 320 billion pesos in liquidity via the RPP facility on the first day of its transition towards the new auction format, its data showed. The ON RPP Rate was 6.2358% on September 8.

Nicholas Mapa, senior economist at ING bank, says the shift will allow the BSP to use a variable amount of securities to influence domestic liquidity conditions. This will increase the central bank’s ability to move rates higher or lower based on prevailing liquidity conditions and demand, he says.

“With more ‘ammunition’ to move rates higher or lower, BSP is more effective in ensuring that market rates are reflective of the BSP desired policy rate,” Mapa says.

In the past, the BSP only had roughly 350 billion pesos worth of bonds for collateral to affect market liquidity, Mapa says. This limited its ability to influence liquidity conditions in the financial markets. However, the BSP’s bond purchase programme during the pandemic has opened the door for the transition now, he says.

Michael Ricafort, chief economist at Rizal Commercial Banking Corporation, a Philippine bank, says the change will help the country develop a more realistic and credible yield curve for market players, instead of being distorted and artificially priced. It will also help promote greater transparency and efficiency in the markets, Ricafort says.

The shift will allow the BSP to transmit its monetary policy in a more dynamic and market-determined manner every business day, he adds.