August 30, 2022 | 00:00
MANILA, Philippines – A rapid rise in inflation could increase the risk of default for borrowers in the Philippines, according to Moody’s Investors Service.
In a report, the Debt Watcher said that an acceleration in inflation has historically led to an increase in non-performing loans (NPLs) among members of the Association of Southeast Asian Nations ( ASEAN).
“While higher interest rates will greatly expand banks’ net interest margins, asset risks will also increase. Nonetheless, we expect interest rates to gradually rise and inflationary pressure to ease in 2023, keeping problem loan growth modest,” said Moody’s Vice President and Principal Analyst Rebecca Tan.
Moody’s said the Philippines had the second highest correlation between inflation and NPLs from 2006 to 2021 for most ASEAN banks at 0.49%, next to 0.6% for Indonesia. .
“That’s because inflation usually leads to an economic downturn, with consequent hikes in interest rates increasing the burden of debt repayment on borrowers,” Tan said.
In terms of the correlation between inflation and credit costs, Moody’s said the Philippines also ranked second after Singapore.
“Banks’ borrowing costs are generally more likely to rise in economies where borrowers’ debt burdens are already heavy and interest rates rise sharply when inflation picks up. In these countries, higher interest rates significantly reduce cash flow for borrowers, who are also negatively impacted by weaker consumer demand and business sentiment,” Moody’s said.
According to Moody’s, borrowers are the most vulnerable to macroeconomic shocks and their debt repayment capacities were already weakened by the pandemic.
He said the Philippines is the least sensitive to increases in loan loss provisions when interest rates rise, while Vietnam is the most sensitive.
Tan said ASEAN central banks would continue to tighten monetary policy as weakening local currencies raised import prices and further worsened capital flows, further aggravated by the hawkish US Federal Reserve.
In the Philippines, the Bangko Sentral ng Pilipinas (BSP) has so far raised interest rates by 175 basis points, bringing the reverse repurchase rate to 3.75% from an all-time low of 2% to curb the rise inflationary pressures.
Inflation averaged 4.7% in the first seven months of the year and exceeded the BSP’s target range of 2-4% after accelerating to 6.4% in July from 6.1 % in June. It should accelerate further and reach an average of 5.4% this year, against 3.9% last year.
“The persistence of supply constraints is also increasing inflationary pressure. The forecast of most ASEAN central banks is that they plan to raise interest rates in the second half of 2022,” Tan said.
In addition, the Debt Watcher said an acceleration in inflation beyond expectations would lead to larger increases in credit costs that would outweigh the benefits of net interest margin gains (NIM ).
Moody’s said the Philippines had the highest correlation between inflation and NIMs at 0.6%, followed by Malaysia and Thailand at 0.4%.
“While ASEAN banks may face pressure to keep lending rates low to support the economic recovery, we expect banks in the Philippines and Singapore to see the largest margin increases in as interest rates rise,” Moody’s said.
According to the credit rating agency, the reason why margins would increase more for banks in the Philippines than for others is due to the larger share of checking and savings accounts (CASA) deposits in total deposits and modest proportions of market funds in total funding mixes.
“Furthermore, we expect interest rates in the Philippines to rise the most among the six ASEAN economies,” he said.