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               4.7                    ISSN 1655-5104

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0.72   136.8   2.3   INFLATION
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0.71   138.1         THIRD Quarter
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       139.3   2.4       2007
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0.70   139.5
       139.6         Bangko Sentral ng Pilipinas
       140.0
       139.8
       139.7
       140.0
       140.4
       141.3
       142.4
       142.6
       142.8
    INFLATION
      REPORT


    Third Quarter
         2007




Bangko Sentral ng Pilipinas
FOREWORD
 
      
     he primary objective of monetary policy is to promote a low and stable rate of

 T   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 4.0-5.0 percent for 2007 and 4.0 percent with a tolerance
interval of ± 1.0 percentage point for 2008.

        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. This issue also features a box article on the US
subprime mortgage market.

            The Monetary Board approved this Inflation Report at its meeting on 25 October
2007.

         
             
             
                                                                             
                                                                                      AM ANDO M . TETANGCO, JR.
                                                                                               Governor
                                                                                            
October 2007
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


                                                                                     ii
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
NPLs      Non-performing loans
NSO       National Statistics Office
OFs       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

       




                                                                 iii
                                  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 Instrument

       The BSP uses the overnight repurchase (RP) rate and reverse repurchase (RRP) rate as
       the key policy rates to set the monetary policy stance. These two interest rates are
       typically adjusted in tandem by the Monetary Board.

       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 2007, the Government’s target for
       annual headline inflation has been set at 4.0-5.0 percent. For 2008, the inflation target
       has been set at 4.0 percent with a tolerance interval of ±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, c reated 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 F inance (DOF).
    The BSP sits as a resource agenc y.


                                                                                                                      iv
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                       Romulo L. Neri
                                   Vicente B. Valdepeñas, Jr.
                                   Raul A. Boncan
                                   Juanita D. Amatong
                                   Nelly F. Villafuerte
                                   Alfredo C. Antonio




                                                                                     v
          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

                 Members                                 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

                                                         Antonio B. Cintura
                                                         Director
                                                         Department of Economic Research;
                                                         Head of Technical Secretariat2




2
    The Advisory Committee is supported by a Tec hnical Secretariat composed of officers and staff from the Department of
    Economic Research, Center for Monetary and Financial Policy, and the Treasury Department.


                                                                                                                            vi
                                         SCHEDULE OF THE MEETINGS ON MONETARY POLICY
                                           AND PUBLICATION OF HIGHLIGHTS FOR 2007-2008


      Mtg. No.             Advisory Committee 1/                        Monetary Board 2/                  Publication of Monetary Board
                                                                                                                     Highlights 3/
                                                                      2007

          1                  22 January, Monday                        25 January, Thursday                      22 February, Thursday
                                                                                                                                          a/
          2                    5 March, Monday                          8 March, Thursday                         4 April, Wednesday

          3                    16 April, Monday                          19 April, Thursday                         17 May, Thursday

          4                    28 May, Monday                            31 May, Thursday                          28 June, Thursday

          5                     9 July, Monday                           12 July, Thursday                         9 August, Thursday

          6                   20 August, Monday                        23 August, Thursday                      20 September, Thursday

                                                                                                                                               b/
          7                   1 October, Monday                        4 October, Thursday                     31 October, W ednesday

          8                 12 November, Monday                      15 November, Thursday                      13 December, Thursday

          9                 17 December, Monday                      20 December, Thursday                    24 January 2008, Thursday


Notes:
1/ Under MB Resolution No. 630, the frequency of meetings of the Advisory Committee and the Monetary Board was set at every six weeks
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 held on the Thursday after the latest Advisory Committee meeting.
3/
     Under MB Resolution No. 630, the lag in the publication of the highlights of the Monetary Board meetings on monetary policy issues
was reduced to four weeks. Prior to this, the highlights were published six weeks after the reference meeting date.
a/ The minutes of the meeting will be published a day earlier since 5 April 2007 (the fourth week after the 8 March 2007
meeting) is a legal holiday (Maundy Thursday).
b/ The minutes of the meeting will be published a day earlier since 1 November 2007 (the fourth week after the 4 October 2007
meeting) is a legal holiday (All Saints' Day).




                                                                                                                                                    vii
                                    CONTENTS
                                              
                                        
Overview                                                      1

I.      Inflation and Real Sector Developments                3

            Prices                                            3

            Aggregate Demand and Supply                      14

            Labor Market Conditions                          24

II.     Monetary and Financial Conditions                    24

            Interest Rates                                   24

            Financial Market Conditions                      27

            Banking System                                   29

            Exchange Rate                                    35

            Monetary Aggregates                              37

            Box Article: The US Subprime Mortgage Market     38

            Fiscal Developments                              45

III.   External Developments                                 46

IV.    Monetary Policy Developments                          51

V.     Inflation Outlook                                     53

            Inflation Forecasts                              53

            Risks to the Inflation Outlook                   57

            Private Sector Economists’ Inflation Forecasts   61

VI.    Implications for the Monetary Policy Stance           62

VII.   Concluding Remarks                                    64

Chronology of M onetary Policy Decisions                     65




                                                                  viii
O VERVIEW

    The inflation environment remained benign in Q3 2007 despite increases in the prices
    of some commodities and services. The headline inflation rate rose slightly during the
    period reflecting uptrends in the prices of food, energy and educational services. The year-
    to-date average inflation rate remained at 2.6 percent, well below the average inflation a year
    ago and the target range for 2007 which is 4-5 percent. Core or underlying inflation, an
    indicator of the long-term trend in price pressures, also averaged higher in Q3 at 2.9 percent
    compared to 2.6 percent in the previous quarter. This, however, was still markedly lower than
    the 5.2 percent core inflation in the same quarter a year ago.

    Output growth continued to broadly strengthen, with Q2 2007 GDP accelerating to 7.5
    percent from the 7.1 percent registered in Q1 2007. On the demand side, GDP growth
    was boosted by strong household spending, improving capital investments, and robust
    government consumption. Likewise, other demand indicators, such as land and rental
    values, residential and office vacancy rates, sales of commercial vehicles and appliances,
    energy consumption, as well as employment, showed improvements in Q2. On the supply
    side, the key driver to growth was services, accounting for more than half of total GDP
    growth. GDP growth was broad-based as other production sectors contributed to the
    economic expansion, with industry output surging by 8.0 percent and agriculture expanding
    by 3.9 percent.

    Domestic interest rates in the primary market rose starting in July following the
    announcement of the higher-than-programmed fiscal deficit for the first semester.
    Primary market interest rates in Q3, although higher than their levels in Q2, were lower
    compared to those of the previous year, indicative of continued ample liquidity in the system.
    Meanwhile, the yield curve shifted downward in Q3 2007 relative to the previous quarter as
    bond prices recovered after falling in the weeks following 17 August, which was the height of
    the fallout in the US subprime mortgage sector.

    Domestic financial markets remained resilient and have stabilized in the face of rising
    global risk aversion due in part to the problems in the US subprime mortgage market.
    Domestic financial markets have recovered by the end of Q3 from their downturn in the days
    leading to 17 August, when US equities experienced a sharp downturn due to the US
    subprime mortgage problem. Investor sentiment improved by the end of Q3 on signs of some
    recovery in global financial markets by September, better fiscal numbers in Q3, and ample
    liquidity in the financial system. Sustained foreign exchange inflows helped maintain the
    firmness of the peso, which still registered an appreciation in Q3 amid the rise in risk
    aversion in August.

    The global economy continued to grow in Q2, but growth is expected to slow down in
    the near term. Growth was mainly supported by buoyant economic activity in emerging
    markets. However, risks to the global economic outlook have increased recently, mainly
    because of the subprime mortgage problem in the US. Global financial markets have
    stabilized after the 18 September 2007 Fed meeting, when the target for the federal funds
    rate was cut by 50 basis points. Subsequently, global equities have recovered and global
    credit spreads have narrowed. Meanwhile, the risk of rising global inflationary pressures
    remained due to increasing resource utilization, capacity constraints, and rising global
    commodity prices.




                                                                                            1
Domestic liquidity growth continued to decelerate for the fourth consecutive month in
August. M3 growth slowed down to 14.9 percent year-on-year in August from 19.4 percent
in June 2007. The growth of domestic liquidity was tempered by the fall in net domestic
assets, following the policy measures implemented by the BSP in May.

The latest baseline forecast indicates a benign inflation outlook over the policy
horizon. The inflation forecast over the policy horizon was lower this quarter compared to
the previous period. Lower actual inflation, significant deceleration of liquidity growth for four
consecutive months, and the firmer peso accounted for the downward revision in the
baseline forecast. Favorable supply of food due to normalizing weather conditions and well-
anchored inflation expectations also helped explain the subdued inflation environment.

Risks to the inflation outlook remain, even as they have moderated. The prospect of
continued strong capital inflows and the resulting expansion in domestic liquidity continue to
pose a risk to the inflation outlook. A resumption of volatility in world oil prices could also
pose a threat to inflation. Possible additional wage hikes and increases in utility rates may
add pressure to inflation as well. In addition, the uptrend in global non-oil commodity prices
could result in higher inflation in 2008.

However, the risks to the inflation outlook are considered to be manageable. The
monetary measures implemented in May have moderated the impact of domestic liquidity on
inflation. In addition, a firm peso is expected to moderate the impact of higher world oil and
global food prices on domestic inflation going forward. The marked improvement in
investments during the quarter would also help mitigate any potential overheating in the
economy as it would help improve the capacity of the economy to absorb additional demand-
side pressures.

On 12 July 2007, the Monetary Board decided to maintain a neutral monetary policy
stance by implementing two complementary moves during its policy meeting. The
tiering system on placements with the BSP was lifted and the BSP’s key policy interest rates
were adjusted to 6.0 percent for the overnight borrowing or reverse repurchase (RRP) rate
and 8.0 percent for the overnight lending or repurchase (RP) rate. The Monetary Board
considered this policy stance as neutral relative to future inflation and output. It noted data
showing the effectiveness of the additional liquidity management measures implemented in
early May 2007. Meanwhile, there were indications that the tiering scheme has had a
beneficial impact on bank lending to the productive sectors of the economy even as non-
bank sources of financing were becoming increasingly available to the corporate sector.

On 23 August 2007, the Monetary Board decided to maintain the BSP’s key policy
interest rates at 6.0 percent for the overnight borrowing or reverse repurchase (RRP)
rate and 8.0 percent for the overnight lending or repurchase (RP) rate.

[Subsequently, on 4 October, the Monetary Board decided to reduce by 25 basis points the
BSP’s key policy interest rates to 5.75 percent for the overnight RRP rate and 7.75 percent
for the overnight RP rate. The Monetary Board considered the benign inflation outlook and
the moderation of risks to future inflation. In addition, the relatively firm peso provided a
buffer against rising global commodity prices, including food and oil, while the impact of
strong foreign exchange inflows on domestic liquidity has been mitigated by recent policy
measures.]




                                                                                          2
I. I NFLATION AND REAL SECTOR D EVELOPMENTS

Prices
Headline inflation inches up in Q3 2007, but                                                         The inflation environment remained benign in the
rem ains well below the target range.                                                                third quarter of 2007 despite uptrends in the prices
Headline Inflation                                                                                   of certain food items, energy and educational
Quarterly average in percent (2000=100)
                                                                                                     services. Headline inflation rose slightly compared
12                                                                                                   to the second quarter of 2007 but remained lower
10
                                                                                                     compared to the average recorded a year earlier.
                                                                                                     The year-to-date average inflation rate remained at
 8                                                                                                   2.6 percent, well below the average inflation a year
                                                                                                     ago and the target range of 4-5 percent for 2007.
 6


 4                                                                                                   Current price pressures have largely been confined
                                                                                                     to specific CPI items, implying that such pressures
 2
                                                                                        Q3:          are not broad-based. Measures of underlying
                                                                                        2.5
 0                                                                                                   inflation have likewise remained low during the
     1995   1996    1997   1998   1999    2000   2001   2002     2003   2004   2005   2006    2007
                                                                                                     period, reflecting the continuing absence of
                                                                                                     significant demand-side pressures in the inflation
                                                                                                     environment.

                                                                                                     The trend continued to support the BSP’s outlook
                                                                                                     of a benign inflation environment over the policy
                                                                                                     horizon. At the same time, the firm peso provided a
                                                                                                     buffer against potential risks stemming from the
                                                                                                     supply side in the form of higher food prices and
                                                                                                     international oil prices, while the impact of strong
                                                                                                     foreign exchange inflows on domestic liquidity has
                                                                                                     been mitigated by recent policy measures.

                                                                                                     Headline and Core Inflat ion

                                                                                                     Average headline inflation inched up to 2.5 percent
                 Quarter- on-
 Contribution to Quarter- on-Quarter Inflation
 in percent
                                                                                                     in the third quarter from 2.4 percent in the second
                                                               Percentage Contribution to
                                                                                                     quarter. This, however, was still lower compared to
                                          Weight in
                   Item
                                         Headline CPI
                                                               Quarter-on-
                                                               Quarter-on-Quarter Headline           the 6.1 percent average inflation posted in the
                                                                        Inflation
                                                                   Q3        Q2      Q3
                                                                                                     same period a year ago and below the target
                                                                  2007      2007    2006             range of 4-5 percent for 2007.
 Core Inflation                             81.6                  2.16      2.02    4.63
 Non-core Items                             18.4                  0.38      0.33    1.48
  Rice                                       9.4                  0.32      0.15    0.18             The slight increase compared to the second
  Corn                                       0.9                  0.04      0.04    0.04             quarter was due mainly to movements in the prices
  Fruits and Vegetables                      5.3                  0.09      0.15    0.52
  Gas, LPG                                   1.3                  0.03      0.05    0.29
                                                                                                     of food, electricity and educational services. Of the
  Kerosene                                   0.3                  -0.02     0.00    0.08             2.5 percent average headline inflation rate, food
  Oil, Gasoline and Diesel                   1.3                  -0.08     -0.05   0.35             accounted for 1.4 percentage points. Fuel, light
 Headline Inflation                        100.0                  2.54         2.35          6.10    and water (FLW), as well as services contributed
                                                                                                     0.3 percentage point each. Housing and repairs
 Source of Basic Data: NSO, BSP
                                                                                                     contributed 0.2 percentage point.




                                                                                                                                                   3
       Contribution to Headline Inflation                                                                        Based on NSO data, the share of both core and
       (In percent)
9.0                                                                                                              non-core CPI items to headline inflation increased
             Food ( Rice, Corn, Fruit s and

8.0
             Vegetables)                                                                                         in Q3 compared to the preceding quarter. Core
             Energy related items (Gas,

7.0
             LPG, Kerosene, Oil, Gasoline $
             Diesel)
                                                                                                                 items in the CPI increased their contribution to 2.2
             Core Inflation

6.0                                                                                                              percentage points in Q3, higher than their 2.0-
5.0
                                                                                                                 percentage-point contribution in Q2. Items that
4.0
                                                                                                                 pushed the contribution of core items in Q3
3.0
                                                                                                                 included electricity, education and some food items
2.0
                                                                                                                 such as meat, eggs, and dairy products. Moreover,
1.0
                                                                                                                 the contribution of non-core CPI items rose slightly
                                                                                                                 to 0.4 percentage point from 0.3 percentage point
0.0
      2003                      2004                  2005                 2006             2007                 in the previous quarter following the increase in
                                                                                                                 rice prices.



Both food and non-food items register higher                                                                     Inflation for food, beverage and tobacco (FBT)
inflation rates in the quarter.                                                                                  increased to 2.9 percent in Q3 from 2.7 percent in
Headline, Food and Non-food Inflation
                                                                                                                 the previous quarter. Likewise, non-food inflation
Quarterly average in percent (2000=100)                                                                          was higher at 2.2 percent compared to 2.0 percent
14
                                                                                                                 in the last quarter.
12

10
                                                                                                                 Relative to year-ago rates, FBT inflation and non-
 8
                                                                                                                 food inflation dropped by 2.3 percentage points
 6
                                                                                                                 and 4.7 percentage points, from 5.2 percent and
 4                                                                                                               6.9 percent, respectively.
 2

 0

-2
     1995    1996       1997      1998        1999   2000    2001   2002    2003   2004   2005     2006   2007
                                                                                   M
                  Headline Inflation                         Food Inflation
                  Non-food Inflation




                                                                                                                                                              4
Core inflation estimates show mixed trends in                                                                           Core or underlying inflation, an indicator of the
third quarter but remain relatively low.                                                                                long-term trend in price pressures, displayed mixed
                                                                                                                        trends during the review quarter. The official NSO
                                                                                                                        core inflation measure averaged higher in Q3 at
 Headline and Core Inflation
Quarterly average in percent (2000=100)
                                                                                                                        2.9 percent compared to 2.6 percent in the
12
                                                                                                                        previous quarter. This, however, was still markedly
                                                                                                                        way below the 5.2 percent core inflation in the
10                                                                                                                      same quarter a year ago.
  8


  6


  4


  2                                                                                                    Q3:
                                                                                                       2.9
  0
      1995   1996    1 997    1998     1999     2000    20 01    2002     2003     2004    2005     2006     2007

                               Headline Inflation                        Core Inflation




 Alternative Core Inflation Measures                                                                                    Meanwhile, alternative measures of core inflation
                        year-on-
 Quarterly aver ages of year-on-year change
                                                                                                                        estimated by the BSP showed contrasting trends.
                                                                                                                        Using the trimmed mean approach, BSP’s estimate
             Quarter                    Trimmed                      Weighted                 Net of Volatile
                                                                                                Items 3/ *
                                                                                                                        of the core inflation for Q3 was higher at 2.3
                                         Mean 1/                     Median 2/
                                                                                                                        percent compared to 2.2 percent in the previous
              2005                            6.2                        5.6                          8.8
               Q1                             6.9                        5.9                          9.9
                                                                                                                        quarter whereas the weighted median approach of
               Q2                             6.4                        5.9                          9.3               measuring core inflation showed a slight
               Q3                             5.8                        5.3                          8.1
               Q4                             5.7                        5.2                          7.8
                                                                                                                        deceleration from 2.2 percent in Q2 to 2.1 percent
              2006                            5.4                        5.0                          6.9               in Q3. On the other hand, the third alternative
               Q1                             5.9                        5.4                          8.1
               Q2                             5.8                        5.0                          7.6               estimate—net of volatile items—showed no
               Q3
               Q4
                                              5.2
                                              4.5
                                                                         5.2
                                                                         4.2
                                                                                                      6.7
                                                                                                      5.0
                                                                                                                        change in core inflation at 2.5 percent.
              2007                            2.6                        2.4                          2.7
               Q1                             2.9                        2.5                          3.0
               Q2                             2.2                        2.2                          2.5
               Q3                             2.3                        2.1                          2.5

1/ The trimm ed mean represe nts the average inflation rate of the (weighted) middl e 70 percent in a lowest-to-
    highest ranking of year-on-year inflation rates for all CPI compo nents.
 2/ The weighted m edia n represents the m iddle inflation rate (correspo nding to a cumulative CPI weight of 50
    percent) in a lowest-to-hi ghest ranking of year-on -year inflation rates.
 3/ The net of volatile item s method excludes the followi ng items: educational services, fruits and vegetables,
    person al services, rentals, recreational services, rice, and corn.
* The series has been recomputed usin g a ne w methodology that is aligned with NSO ’s meth od of computing
    the official core inflation, which re-weights rem aining items to comprise 100 p ercent of the core b asket after
    excluding no n-co re item s. The previous meth odol og y retain ed the weights of volatile items in the CPI
    basket while keeping their indices constant at 100.0 from m onth to month.
 Source: NSO, BSP estimates




                                                                                                                                                                    5
                                                                                               Looking at the distribution of price changes in the
                                                                                               CPI basket, it is useful to determine the proportion
                                                                                               of the CPI basket components (at the 4-digit
                                                                                               Philippine Standard Industry Classification (PSIC)
                                                                                               level) showing inflation rates above a given
                                                                                               threshold—in this case the upper end of the 4.0-
                                                                                               5.0 percent target for 2007—to find out whether
                                                                                               that proportion has been increasing or decreasing.
                                                                                               This would indicate whether pressures on
                                                                                               consumer prices are becoming generalized over
                                                                                               time.




Data show m ore CPI items with above-target                                                    The number of items with inflation rates greater
inflation rates.                                                                               than the threshold of 5 percent increased to 24 in
                                                                                               Q3 from 18 in Q2 but was still lower compared to
CPI Items with Inflation Above Threshold                                                       63 posted a year earlier. Likewise, these items
                                                                                               accounted for a higher proportion of the CPI basket
90                                                                                             at 16.6 percent compared to 8.9 percent in the
80
                                                                                               previous quarter. This, however, was also lower
70

60
                                                                                               relative to the 41.6 percent recorded a year ago.
50

40                                                                                             Specifically, there were 15 food items with inflation
30                                                                                             rates above threshold compared to 8 in the
20
                                                                                               previous quarter.        Meanwhile, 9 non-food
10
                                                                                               commodities posted inflation rates higher than the
 0
     Q1   Q2    Q3    Q4    Q1   Q2       Q3   Q4   Q1    Q2   Q3    Q4    Q1    Q2    Q3      upper end of the 2007 target in the current quarter
            2004                       2005                 2006                2007
                                                                                               compared to 10 a quarter earlier.
      Cumulative Weight (in percent)           Number of Items Exceeding Threshold Inflation




                                                                                                                                             6
                                                                     Food Prices

Adverse weather conditions trigger an increase                       Food inflation, which has been declining steadily
                                                                     for the past five quarters since Q2 2006, reversed
in food prices in Q3.
                                                                     its trend in Q3 2007 as all food items—except for
                                                                     fish, fruits and vegetables, miscellaneous food, and
Inflation Rates for Selected Food Items                              beverages—registered higher price increases.
Quarterly aver ages in percent (2000=100)
                                 2007                   2006         The uptick in food inflation was due largely to the
         Commodity
                                  Q3        Q2    Q1    Q4     Q3    gradual uptrend of retail prices of commercial rice
Food, Beverage and Tobacco        2.9       2.7   3.3   4.9    5.2   since the last two weeks of August. Rice
Food                              2.9       2.6   3.3   4.9    5.2   constitutes 9.36 percent of the CPI basket. The
Cereal & Cereal Products          3.5       2.2   2.7   2.9    3.1   recent dry spell experienced in key areas of
o/w Rice                          3.4       1.6   1.6   1.4    1.9
     Corn                         4.3       4.1   6.7   9.3    4.9   northern Luzon and Visayas from June 2007 to the
Dairy Products                    5.5       4.1   4.4   5.5    5.9   first two weeks of August had adversely affected
Eggs                              7.6       6.3   5.5   6.1    5.5
Fish                              2.6       3.3   3.4   5.2    5.6   rice production. The prolonged dry weather
Fruits & Vegetables               1.7       2.8   3.8   8.6    9.9   conditions that resulted in delayed harvests in the
Meat                              3.1       2.4   2.3   2.9    1.9
Misc. Food                        1.9       2.3   3.8   6.3    7.8
                                                                     affected areas, brought about the tight supply of
Beverages                         2.9       3.5   5.4   6.0    6.4   palay which, in turn, contributed to the surge in
Tobacco                           2.4       2.1   2.2   2.8    3.2   domestic rice prices during the quarter.
Source of Basic Data: NSO, BSP




                                                                     Similarly, prices of food products such as dairy,
                                                                     corn and cereal preparations increased during the
                                                                     period, due mainly to higher international food
                                                                     prices brought about by the increasing use of some
                                                                     food items as sources of fuel (e.g., corn, soybean,
                                                                     rapeseed oil), the rising food consumption in
                                                                     emerging markets, and the occurrence of
                                                                     unfavorable weather conditions which have
                                                                     reduced the harvest for some of these food items.



                                                                     Meanwhile, higher input costs (i.e. vaccine, feeds)
                                                                     and the strong external demand for chicken abroad
                                                                     resulted in higher prices of meat—particularly
                                                                     chicken—and eggs, which rose by 3.1 percent and
                                                                     7.6 percent, respectively, from the 1.9 percent and
                                                                     5.5 percent inflation registered in the same period
                                                                     last year. The increase in prices was due partly to
                                                                     the upward trend in the price of feeds (yellow corn
                                                                     and soybean meal) because of the high demand
                                                                     for these items in the global market, reflecting the
                                                                     increasing use of corn and other food products for
                                                                     biofuel production. Meanwhile, the tightness in
                                                                     poultry supply has subsequently affected egg
                                                                     production.




                                                                                                                  7
                                          Looking ahead, food prices are likely to remain
                                          stable, as the Government has implemented
                                          measures to ensure the stability of the supply and
                                          price of rice during the lean months in Q3. These
                                          measures included: strict monitoring of the price
                                          movement of commercial rice stocks; increasing
                                          rice allocation to retailers who adhere strictly to the
                                          rules and regulations of rice trading; and mobile
                                          delivery of rice to accredited outlets. In addition,
                                          the National Food Authority increased the volume
                                          of government rice distributed in Metro Manila and
                                          nearby central and southern Luzon to counter the
                                          uptrend in commercial rice prices as well as
                                          expectations of higher rice prices brought about by
                                          the probability of lower palay yield in Q3 following
                                          the prolonged dry spell in these areas.



                                          Nonetheless, agricultural output growth is expected
                                          to continue, supported by public spending on seed
                                          technology and rural infrastructure. Moreover, the
                                          risks to the production of hogs due to swine flu
                                          have been addressed. However, there remain
                                          some downside risks due to the uptrend in the
                                          international prices of rice and corn and a La Niña
                                          weather incidence which could adversely affect
                                          agricultural production.


                                          Non-Food Prices

Likewise, energy costs push up non-food   Non-food inflation rose slightly during the quarter,
inflation in the third quarter.           driven mainly by the uptick in fuel, light and water
                                          (FLW), which has been increasing since Q2 2007.
                                          FLW inflation, which accounts for 6.95 percent of
                                          CPI, was higher at 4.3 percent in Q3 as against 3.3
                                          percent in the previous quarter, but was
                                          considerably lower than the 13.7 percent inflation
                                          registered in the same period last year.




                                                                                         8
Inflation Rates for Selected Non-Food Items
                             Non-                                                    The increase in FLW prices was due to the rise in
Quarterly aver ages in percent (2000=100)                                            power rates during the quarter as the Energy
                                                                                     Regulatory Commission (ERC), in its 28 June 2007
                                     2007                         2006
          Commodity                                                                  decision, allowed Meralco to automatically pass
                                      Q3         Q2        Q1      Q4           Q3   on to its customers adjustments in its generation
Non-Food Items                        2.2        2.0        2.4    4.7        6.9    charges. 3 In July 2007, Meralco started reflecting
Clothing                              2.1        2.5        2.8    3.0        3.1
Housing & Repairs                     1.3        1.5        2.2    3.7        3.8
                                                                                     applicable generation rates—an increase of
Fuel, Light & Water                   4.3        3.3        2.4    8.1       13.7    around P1/kwh—in the bills of its customers.4
  Fuel                                0.8        3.5       -1.1    5.3       20.5    However, Meralco, using the same automatic rate
  Light                               6.8        2.8        3.8   10.5       10.7
                                                                                     adjustment mechanism, reduced power rates in
  Water                               4.5        5.0        6.9    6.5        7.3
Services                              2.1        2.1        2.8    4.9        8.7    August and September.
Transpo & Comm.                      -1.1       -0.5        0.5    4.4       11.7
Miscellaneous                         1.4        1.6        2.1    2.6        3.0
                                                                                     Meanwhile, all other sub-components of non-food
Source of Basic Data: NSO, BSP                                                       items registered declines during the quarter
                                                                                     compared to a year ago and the previous quarter,
                                                                                     except for services which was steady at 2.1
                                                                                     percent in Q2 and Q3.

                                                                                      Energy Prices
International oil prices continue to rise on supply
concerns and expectations of higher global                                            International oil prices averaged higher in Q3 on
dem and for crude oil.                                                                expectations of increased global demand for oil
   Dubai Crude Oil                                                                    and supply concerns due to the hurricane
   Quarterly average spot price in US dollars per barrel                              season. Dubai crude oil reached an average of
  75
                                                                                      US$70.08 per barrel, higher by 8.2 percent
                                                                     Q3 US $70.0 8
                                                                                      compared to the previous quarter’s average of
  65
                                                                                      US$64.79 per barrel.
  55

  45

  35

  25

  15

   5
       1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007




         3
           The Department of Energy amended on 21 June 2007 Section 4 (e) of Rule 3 of the Implementing Rules and
         Regulations of the Electric Power Indus try Reform Ac t (EPIRA), whic h in effect now excludes GRAM and ICERA
         adjustments, among others, from the lis t of adjustments that require prior ERC approval.
         4
           Sourc e: Meralco-Utility Economics, 30 July 2007.




                                                                                                                                 9
 Local pump prices of oil products are higher                                                   In the domestic market, average pump prices of
 during the quarter, reflecting the increase in                                                 gasoline products and diesel oil were higher
 world oil prices.                                                                              during Q3 relative to the previous quarter. Oil
   Local Retail Prices of Selected Oil Products                                                 companies raised prices three times during the
  Price in pesos per liter                                                                      quarter (28 July, 22 and 29 September) reflecting
  51                                                                                            higher international oil prices. Prices were
  46                                                                                            reduced once in early September, which could be
  41                                                                                            attributed to relatively lower world prices in early
  36                                                                                            August 2007.
  31
  26
  21
  16
  11
   6
   1998       1999      2000      2001     2002      2003    2004   2005      2006       2007

                     Premium Gasoline                           Diesel Oil




 Outlook for world prices remains on an                                                         The estimated futures price of Dubai crude oil
 uptrend.                                                                                       sustained its uptrend and remained highly volatile
                                                                                                in Q3. While concerns on the US subprime
Spot and Estimated Future Prices of Dubai Crude Oil*
                                                                                                mortgage market weakened the price of oil
Price in US dollars per barrel                                                                  futures, oil prices rebounded subsequently and
 80
                                                                        as of 28-Sep-07
                                                                                                resumed their uptrend on expectations that world
 70
                                                                                                demand for oil would continue as the 18
                                                                                                September cut in the target for the US Federal
 60
                                                                           as of 29-Dec-06      Funds rate was expected to support world
 50                                                                     as of 4-Jul-07          economic expansion. In addition, the following
 40                                                                                             factors contributed to the continued uptrend in oil
 30                                                                                             prices: 1) tight global oil supply, and 2) the onset
 20
                                                                                                of the hurricane season, which affected the
                                                                                                outlook for the supply of oil.
 10
   2000       2001      2002      2003      2004      2005   2006   2007       2008
  *Futures price derived using Brent crude futures data.




                                                                                                                                           10
                                                                     Utility Charges

Power rates seesaw in Q3; register net increase.                     Power

                                                                     Notwithstanding the generation rate reductions by
                                                                     the National Power Corporation (NPC) in July
                                                                     with the onset of the wet season,5 a net increase
                                                                     in retail electricity rates was posted in Q3
                                                                     following the restoration of the Automatic
                                                                     Generation Rate Adjustment (AGRA) in June.

                                                                     Nonetheless, the effect of the cut in generation
                                                                     charges was generally felt in the latter part of Q3
                                                                     2007, as Meralco cut its rates for August and
                                                                     September. Moreover, consumers are expected
                                                                     to benefit from another round of power rate
                                                                     reductions in the last quarter of 2007. Supporting
                                                                     this outlook is the ERC’s decision to grant NPC a
                                                                     provisional authority through the generation rate
                                                                     adjustment mechanism (GRAM) and incremental
                                                                     currency exchange rate adjustment (ICERA) to
                                                                     reduce rates by as much as P0.25/kwh in Luzon,
                                                                     P0.07/kwh in Visayas, and P0.06/kwh in
                                                                     Mindanao starting in October 2007.

                                                                     Since March 2007, NPC rates have been
                                                                     reduced by P0.60/kwh in Luzon, P0.50/kwh in
                                                                     Visayas, and P0.28/kwh in Mindanao.




     5
       Prices are lower during the wet seas on from July to Dec ember, as demand usually falls when the rains come due to
     milder weather conditions and the increas ed utilization of hydroelectric plants which are cheaper sources of electric ity.
     The Visayas grid, however, did not enjoy the lower generation rate reductions bec aus e there are no hydroelectric plants in
     the region.




                                                                                                                             11
Government and private sector introduce           However, the restoration of the Automatic
initiatives to lower electricity rates to boost   Generation Rate Adjustment (AGRA), the ERC’s
competitiveness in the industries.                recent ruling on the alleged ‘price manipulation’ in
                                                  the WESM, and the approval of Meralco’s
                                                  distribution charge under the performance-based
                                                  rate (PBR) application are seen to increase
                                                  power rates starting in 2008.

                                                  On other industry developments, ERC granted
                                                  Meralco and NPC clearance to implement a
                                                  Memorandum of Agreement that calls for the
                                                  provision of preferential generation rates to high
                                                  load factor industrial customers accredited by the
                                                  Philippine Economic Zone Authority (PEZA).
                                                  Moreover, PEZA has already issued the
                                                  guidelines for the ‘open access’ system in
                                                  ecozones. Under this system, industrial
                                                  customers will be connected directly to high-
                                                  voltage transmission lines, thus reducing the
                                                  direct cost of power. President Arroyo has also
                                                  signed Executive Order (EO) No. 661 on 10
                                                  September 2007, inviting factories and other
                                                  heavy power users to put up their operations
                                                  around the cheaper-rated geothermal power
                                                  plants.

                                                  In a more recent development, Meralco lowered
                                                  its rates in early October 2007 for the third
                                                  consecutive month given the lower power
                                                  charges by suppliers, improved dispatch and a
                                                  firmer peso. A P0.54/kwh additional reduction
                                                  was likewise passed on in October as a result of
                                                  the mandated rate reduction (MRR) from power
                                                  supply sourced from the NPC. More reductions
                                                  under the MRR are expected pending NPC’s
                                                  calculation for the periods not covered in the
                                                  October computation.




                                                                                             12
Water rates decline in Q3.                                         Water

                                                                   For Q3, Manila Water Co. Inc. (MWCI) and
                                                                   Maynilad     Water    Services    Inc.    (MWSI)
                                                                   implemented another downward adjustment in
                                                                   the Foreign Currency Differential Adjustment
                                                                   (FCDA) component of their basic charge this
                                                                   quarter as a result of the continued increasing
                                                                   strength of the peso against the US dollar. FCDA
                                                                   adjustments of MWCI and MWSI turned negative
                                                                   at P0.37/m3 and P0.44/m3 , respectively. This is
                                                                   the third time this year that the Metropolitan
                                                                   Waterworks and Sewerage System (MWSS) has
                                                                   reduced the FCDA adjustments charged by the
                                                                   Manila water concessionaires.6

                                                                   However, in a more recent development, the
                                                                   MWSS decided to grant MWCI and MWSI an
                                                                   increase in their water rates for the fourth quarter
                                                                   despite a relatively firm peso. This brings the
                                                                   fourth quarter FCDA rates for MWCI and MWSI
                                                                   to negative P0.23/m3 and P0.17/m3 , respectively.




    6
        The Foreign Currency Differential Adjustment (FCDA) component is subjec t to quarterly review by the MWSS.




                                                                                                                     13
    Aggregate Demand and Supply

    Economic growth surges to 7.5 percent in Q2                                                              GDP growth accelerated to 7.5 percent in Q2 2007.
    2007.                                                                                                    On the demand side, GDP growth was boosted by
                                                                                                             strong household spending, improving capital
     GDP and GNP Growth Rates                                                                                investments, and robust government consumption.
     Annual Growth in Real Terms                                                                             On the supply side, the key driver to growth was
    10
                                                                                                             services, accounting for more than half of total GDP
     8                                                                                                       growth. GDP growth was broad-based as other
     6                                                                                                       production sectors contributed to the economic
     4                                                                                                       expansion, with industry output surging by 8.0
     2                                                                                                       percent and agriculture expanding by 3.9 percent.
     0
                                                                                                             The hefty 16.6 percent growth in Net Factor Income
     -2
                                                                                                             from Abroad (NFIA) pushed up the Q2 growth in
     -4
                                                                                                             Gross National Product (GNP) to 8.3 percent.
      1995     1996    1997    1998    1999    2000   2001   2002   2003    2004    2005   2006   2007

                              GDP                                          GNP                               Year-to-date GDP growth was 7.3 percent, higher
*  Data for 1995-2003 is based on the old series of the National Income Accounts
                                                                                                             than the Government’s full-year growth target range
(NIA) of the NSCB. T he quarterly GDP data from Q1 2004-Q1 2007 has been revised                             of 6.1-6.7 percent.
b y the NSCB as of May 2007. The revision in volves the addition or re-estimation of
s ourc e subsec tors under bus iness process outsourcing (BPOs), manufac turing, and
c onstruction. The target for the releas e of the revised series from 1980-2003 is on
December 2007.




                                                                                                             Aggregate Demand
    Robust consumption spending and improving                                                                Expenditures (by m ajor economic sectors)
    investment boost aggregate demand.
     Domestic Demand
                                                                                                             Personal consumption expenditure (PCE) remained
     Annual Growth in Real Terms                                                                             the key driver of aggregate demand, expanding by
     30
     25
                                                                                                             6.0 percent in Q2 on the back of election-related
     20                                                                                                      spending and strong inflows of overseas Filipinos’
     15
     10                                                                                                      (OF) remittances. Expenditures on food, which
          5
          0
                                                                                                             comprised over half of total PCE, rose at a steady
      -5                                                                                                     pace of 6.4 percent. Household spending on
     -10
     -15
                                                                                                             beverage,       clothing   and      footwear,    and
     -20                                                                                                     miscellaneous items registered higher growth rates
     -25
       1995     1996    1997    1998    1999    2000    2001   2002   2003       2004   2005   2006   2007   relative to the previous year, while expenditures on
              Govt. Spending                  Private Consumption                   Fixed Investment         fuel, light and water increased by 6.0 percent after
                                                                                                             declining by 2.2 percent a year ago.




                                                                                                                                                         14
Economic Performance
Growth rate (in percent)                                                           Growth in government consumption accelerated to
                                                    2007                    2006   13.5 percent in Q2, buoyed by public infrastructure
              Sector
                                              Q2                Q1           Q2
                                                                                   and election-related spending. Investments in fixed
By expenditure item
                                                                                   capital posted a double-digit growth of 10.0
Personal consumption                          6.0            5.9             5.4   percent, driven by the 18.9 percent surge in
Government Consumption                    13.5               9.9             3.3   construction investments. This marked a significant
Capital Formation                          8.2               6.9             1.5   improvement in fixed capital investment from the
 Fixed Capital Formation                  10.0               8.5            -1.0   year-ago decline of 1.0 percent in Q2 and the
Exports                                    4.2                9.9           21.2   modest increase of 1.4 percent for the whole year
Imports                                   -11.2              -2.1            4.0   of 2006.
Source: NSCB




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

                                                   2007              2006          Based on the Balance of Payments (BOP) data,
      Commodity Group                                                              imports of goods rose by 4.6 percent year-on-year
                                         Q2                Q1         Q2
 Capital Goods                          -1.3              11.8        0.0          to US$14.1 billion in Q2 2007, a deceleration from
 Raw Materials & Intermediate
                                         1.0              8.8        10.4
                                                                                   both the levels posted in the previous quarter and
 Goods                                                                             the previous year. 7 Except for capital goods, all
 Mineral Fuels & Lubricant              9.6               -8.8       29.4
 Consumer Goods                         28.1              -1.0       -4.2          major commodity groups posted year-on-year
 Total Imports1/                        3.2                5.8       10.0          increases in Q2 with consumer goods imports
 Conceptual and coverage                                                           posting the highest increase of 28.1 percent.
  adjustments                          -249.4             240.5      -35.2
 Total Imports, BPM5                     4.6               7.5       10.5          Mineral fuels and lubricants likewise improved by
                                                                                   9.6 percent from a decline of 8.8 percent in the
 1/
  Include valuation adjustments to NSO data
 Source: BSP
                                                                                   previous quarter due mainly to higher prices of oil
                                                                                   in the international market. For January-June 2007,
                                                                                   merchandise imports increased at a slower pace of
                                                                                   4.9 percent compared to 13.0 percent a year ago.




          7
            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 pric es. Imports per BOP are bas ed on BPM5 concept (i.e., exc luding from the NSO foreign
          trade figures those goods that did not involve change in ownership) and reflect among other things: a) upward
          adjustments on the valuation of consigned raw materials for elec tronics and garments exports; b) OF remittances in kind;
          and c ) military imports. Based on the Q2 2007 NIA, merchandise imports based on constant 1985 peso pric es dec lined by
          12.3 percent in Q2, following a 3.4 percent drop in Q1 and a 4.1 percent increase in Q2 2006. Meanwhile, NSO data for
          July reflected a 14.3 percent year-on-year growth in total merchandise imports from the 3.8 pe rcent growth in June.




                                                                                                                               15
                                                                           Other Demand Indicators

                                                                           Other indicators of demand showed broad
                                                                           strengthening. Property prices and occupancy
                                                                           rates   increased, consumer and         business
                                                                           confidence improved, and sales of automobiles,
                                                                           appliances and power continued to grow.

                                                                           •   Based on latest data for Q2 2007 from Colliers
                                                                               International Research, land values rose by 6.8
                                                                               percent year-on-year for the Makati Central
                                                                               Business District (CBD) and 14.2 percent for
                                                                               Ortigas    Center. Quarter-on-quarter, the
                                                                               estimated land values in the Makati and
                                                                               Ortigas CBD as of end-June 2007 were 5.6
                                                                               percent and 6.7 percent higher relative to the
                                                                               end-March levels. Colliers noted that land
                                                                               values have been appreciating due to
                                                                               increased pricing power of developers in both
                                                                               office and residential segments; impressive
                                                                               take-up in residential pre-sales market; and
                                                                               pre-lease take-up in the office market. 8 Colliers
                                                                               expects land values to rise further by 9-10
                                                                               percent year-on-year in Q2 2008.



          *Average Land Va lues, Maka ti CBD and Ortigas
          Real prices , based on CPI (1991= 100)
          (in pesos per s quare meter)
                                                                           •   Office rents in the Makati CBD increased by
300,000                                                                        27.8 percent year-on-year to an average of
250,000
                                                                               P738/sq.m. and are forecast to rise further by
                                     Makati       Ortigas
                                                                               11.4 percent to P822/sq.m. by Q2 2008. Rents
200,000                                                                        for 3-bedroom condominium units in the same
150,000
                                                                               area rose by 20.7 percent year-on-year to
100,000                                                                        P519/sq.m. in Q2 2007 and are seen to rise
                                                                               further by 5.1 percent year-on-year in Q2 2008.
 50,000


     0


           199 8   2001   200 2   2003    200 4    2005     200 6   2007




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




          8
             Colliers International The Knowledge Report: Philippine Property Market Overv iew, July 2007, available at
          http://www.c olliers.com




                                                                                                                        16
 Office a nd Residential Rental Values                                        •   Land values were around 50-60 percent of
 Real prices, bas ed on CPI (1995=100)                                            their 1997 levels in nominal terms and around
 (in pesos per square meter per month)
1,0 00
                                                                                  one-third of the 1997 levels in real terms.
  900                                                                             While rental values for the same period were
  800                         Off ice rental v alue
                              R esidential rental v alue
                                                                                  approaching their peak levels in the 1990s in
  700
                                                                                  nominal terms, they remained only about two-
  600
                                                                                  thirds of their 1997 levels after correcting for
  500

  400
                                                                                  inflation.
  300

  200

  100

     0
         1998   2001   2002   200 3       200 4       200 5   200 6   200 7




                                                                              •   Colliers also reported that residential rents in
                                                                                  Rockwell inched up by 2.3 percent to
                                                                                  P622/sq.m. in Q2 2007. For the remainder of
                                                                                  2007, Colliers expects rents to increase further
                                                                                  by about 3.0 percent to P639/sq.m.
                                                                                  Residential rents in Fort Bonifacio rose by a
                                                                                  modest      1.1   percent    year-on-year     to
                                                                                  P559/sq.m. and are expected to increase
                                                                                  further by around 4.0 percent to P580/sq.m. by
                                                                                  year-end.


                                                                              •   Office and residential vacancy rates in the
                                                                                  Makati CBD as of Q2 2007 continued to
                                                                                  decline to 3.4 percent and 7.1 percent,
                                                                                  respectively. Colliers expects the office
                                                                                  vacancy rate to be at 3.7 percent in Q2 2008
                                                                                  due to continued demand for office space by
                                                                                  the business process outsourcing (BPO)
                                                                                  sector, and the residential vacancy rate to
                                                                                  decline to 5.1 percent by Q2 2008 with only a
                                                                                  single residential condominium project (the
                                                                                  Columns Tower 2 in Makati) slated for
                                                                                  completion by end-2007.




                                                                                                                         17
                                                                                   •   Sales of passenger cars in Q3 2007 rose by
      Sales of Passenger Cars and Commercial Vehicles
  Year-on-year change in percent
                                                                                       5.3 percent year-on-year, lower than the year-
                                                                                       ago growth of 10.2 percent but higher than the
  200                                                                                  previous quarter's 2.4 percent. Cumulative
  150                                                                                  sales for the first three quarters increased by
  100
                                                                                       5.7 percent, higher than the 4.5 percent
                                                                                       growth registered in the comparable period
      50
                                                                                       last year, which the Chamber of Automotive
       0
                                                                                       Manufacturers Association of the Philippines
      -50                                                                              (CAMPI) attributed largely to the launch of new
  -100                                                                                 models and the continuous arrival of vehicle
        2003          2004             2005          2006            2007
                                                                                       stocks to meet growing demand.
                      Passenger Cars                 Commercial Vehicles



                                                                                   • The year-on-year growth in sales of commercial
                                                                                     vehicles for Q3 2007 remained strong at 22.4
                                                                                     percent, though lower than the 24.9 percent
                                                                                     increase in Q2 2007. Cumulative sales for the
                                                                                     first nine months were 23.5 percent higher than
                                                                                     the year-ago level.

                                                                                   • Similarly, sales of trucks and buses for the first
                                                                                     two months of Q3 declined slightly by 1.2
                                                                                     percent year-on-year, after increasing by 29.9
                                                                                     percent and 33.8 percent in Q2 2007 and July-
                                                                                     August 2006, respectively. However, sales for
                                                                                     the first eight months of 2007 surged by 25.8
                                                                                     percent, more than double the year-ago growth
                                                                                     of 9.4 percent. 


  Meralco Power Sales
Year-on-year change in percent                                                     •   Energy sales by Meralco rose at a faster pace
15                                                                                     of 6.7 percent year-on-year in July compared to
                                                                                       4.6 percent in Q2 2007 and 1.8 percent in the
10                                                                                     same month in 2006. Sales for the first seven
                                                                                       months of 2007 rose at a faster pace of 4.6
 5
                                                                                       percent compared to 1.7 percent in the
                                                                                       comparable period last year. Meralco attributed
 0
                                                                                       this to the growing economy, widening
 -5
                                                                                       customer     base     and      higher   energy
                                                                                       consumption, particularly in the commercial
-10
                                                                                       sector.
  2000         2001     2002       2003       2004     2005        2006     2007




                                                                                                                              18
                                                                                                •   Appliance sales declined at a slower pace of
  Appliance Sales
  Year-on-year change in percent
                                                                                                    1.5 percent year-on-year in Q3 2007 relative to
                                                                                                    the 6.0 percent drop registered in the
30
                                                                                                    comparable period last year. It was a downturn
20
                                                                                                    relative to the 9.0 percent increase in Q2 2007.
10
                                                                                                    However, cumulative sales for the first nine
  0
                                                                                                    months of 2007 inched up by 5.0 percent after
-10
                                                                                                    declining by 7.0 percent a year ago.
-20

-30

-40

-50

-60
       J F    M A M      J    J   A S     O N    D     J    F M A M J            J    A     S
       2006                                                    2007




 Average Capacity Utilization for Manufacturing                                                 •   Based on the NSO’s Monthly Integrated Survey
 In percent                                                                                         of Selected Industries (MISSI), average
100                                                                                                 capacity utilization in the manufacturing sector
  95                                                                                                increased slightly in July to 80.3 percent from
  90                                                                                                an average of 80.1 percent in Q2 and 80.2
  85                                                                                                percent in July 2006.
  80

  75

  70

  65

  60

  55

  50
   2000        2001     2002       2003         2004         2005      2006           2007




 Growth in Volume and Value Indices of Manufacturing Production
 Year-on-year change in percent                                                                 •   The value of production index (VAPI) inched up
30
                                                                                                    by 1.4 percent in July following a decline of 3.1
                                                                                                    percent in Q2 2007. It was a slowdown from
20
                                                                                                    the 2.7 percent growth registered in July 2006.
10                                                                                                  Meanwhile, the volume of production index
 0
                                                                                                    (VOPI) rose marginally by 0.6 percent in July
                                                                                                    after declining by 5.1 percent in the previous
-10
                                                                                                    quarter and by 10.8 percent in the same month
-20                                                                                                 last year.
-30
  2000        2001     2002       2003      2004           2005       2006           2007

                 Volume of Production                      Value of Production




                                                                                                                                            19
                                                                        •   Results of the latest Business Expectations
                                                                            Survey (BES) for Q3 2007 showed that
Business Expectations Survey
                                                                            business confidence continued to be buoyant.
Index                             2007                    2006
                                                                            The overall business confidence index (CI)
                         Q3       Q2        Q1     Q4            Q3
                                                                            remained at the 40.0 percent mark for the
Business Outlook Index
                                                                            fourth consecutive quarter at 40.9 percent, up
  Current Quarter        40.9     46.4      44.9   49.4          21.7
  Next Quarter           53.0     44.7      49.4   37.1          40.9
                                                                            by 19.2 index points compared to the year-ago
                                                                            level. However, the quarter-on-quarter index
Source: BSP                                                                 fell by 5.5 points, consistent with the perception
                                                                            during the Q2 survey that the Q3 index would
                                                                            be slightly lower compared to Q2. The slightly
                                                                            more cautious business outlook in Q3 2007
                                                                            relative to the previous quarter was attributed
                                                                            by respondent firms to the following factors: 1)
                                                                            slackening of production for Q3 due to
                                                                            seasonality; 2) possible slowdown in the US
                                                                            economy due to problems in the housing
                                                                            market; 3) competition posed by cheap imports
                                                                            coming from China; 4) increase in crude oil
                                                                            prices; and 5) power and water shortages. For
                                                                            Q4 2007, respondents expected that business
                                                                            activity would surge as the index climbed to
                                                                            53.0 percent, the highest level since the survey
                                                                            was first conducted in Q2 2001.




                                                                        •   Consumer confidence continued to improve in
     Consumer Expectations Survey                                           Q3 2007. The nationwide consumer CI for Q3
     Index                               2007
                                                                            2007      sustained its      improving trend to
                                                                            -23.6 percent from -26.0 percent in Q2. The
                            Q3            Q2         Q1
                                                                            more upbeat consumer outlook for the current
     Current Quarter      -23.6          -26.0      -33.3                   quarter was buoyed by favorable economic
     Next 3 months          4.1           -6.7      -11.1                   conditions, higher family incomes and better
     Next 12 months         7.9           5.8         0.8                   family financial positions. Survey results also
                                                                            showed that more households anticipate better
     Source: BSP                                                            economic and family financial conditions in Q4
                                                                            as the index turned positive at 4.1 percent.
                                                                            Likewise, the confidence index for the next 12
                                                                            months increased to 7.9 percent from 5.8
                                                                            percent in the last quarter.

                                                                            Notably, the improvement in overall outlook
                                                                            was felt most keenly by low-income consumers
                                                                            (with monthly income of less than P10,000)
                                                                            who anticipated better conditions for Q3 2007.




                                                                                                                     20
                                                                   External Demand

Exports grow m oderately.                                          Total exports of goods based on the BOP9
                                                                   increased by 5.0 percent in Q2 2007 to US$12.2
                                                                   billion as all key commodity groups, except sugar
                                                                   and related products, rose from their year-ago
                                                                   levels. This was, however, a slowdown from the
                                                                   quarter- and year-ago growth of 12.0 percent and
                                                                   20.0 percent, respectively.10




Exports of Goods per BOP                                           Exports of mineral and petroleum products posted
                                                                   the highest growth rates among the major
Growth rate (in percent)
                                                                   commodity groups. Electronics exports, which
                                        2007           2006        accounted for 63.4 percent of total exports of
     Commodity Group
                                 Q2            Q1       Q2         goods, increased at a slower pace of 3.1 percent in
Coconut products                 9.7           -33.9    -9.3       Q2 from 10.3 percent in Q1 as a result of rapid price
                                                                   attrition experienced in the world electronics market
Sugar and Products              -16.3          -24.9    -4.0
                                                                   due to the increasing competition among global
Fruits and Vegetables           3.4             2.7    15.6
                                                                   manufacturers.
Other Agro-based products       1.8             9.8    13.8
Forest products                 24.1           99.1    -23.9
Mineral products                35.9            84.4   130.2
Petroleum products              44.2           -29.1   61.3
Manufactures                     3.3             9.8   15.1
Total Exports, as per NSO
                                 4.2           11.5    19.7
 Foreign Trade Statistics
Conceptual and coverage
                                38.4           -12.7    -4.5
 adjustments
Total Exports, BPM5              5.0           12.0    20.0

Source: BSP




       9
         Based on BPM5 concept (i.e., excluding from the National Statistic s Offic e (NSO) foreign trade figures those goods that
       did not involve change in owners hip)
       10
          Based on the Q2 2007 NIA, merchandise export growth based on constant 1985 peso prices decelerated to 5.9 percent
       in Q2 from 10.7 percent in the previous quarter and 21.7 percent in the previous year.




                                                                                                                              21
                                                         Aggregate Supply

Major production sectors, led by services, boost         On the supply side, GDP growth was boosted by
output growth in Q2.                                     services, which posted an 8.4 percent increase in
                                                         Q2 due mainly to gains in transportation,
                                                         communication and storage (TCS), trade, private
                                                         services and finance. Growth in communications
                                                         accelerated on the back of higher revenues from
                                                         landline, mobile phone and broadband services,
                                                         while growth in land and air transport improved due
                                                         to increased patronage of the rail system and
                                                         aggressive fare promotions by domestic airlines.11
                                                         Trade services were buoyed mainly by retail trade,
                                                         which owed its robust performance to newly-opened
                                                         malls and supermarkets. Growth in finance
                                                         remained driven by banks, which posted a more
                                                         than three-fold increase in growth of value added in
                                                         Q2. Private services were boosted mainly by the
                                                         business services sector, particularly the BPO
                                                         industry. Increased renting and leasing operations
                                                         of supermalls, shopping centers and offices were
                                                         reflected in the higher growth of ownership of
                                                         dwellings and real estate.




    11
       NSCB Press Release, “Philippine Ec onomy Stronger at 7.5 Percent GDP Growth,” 30 August 2007, available at
    http://www.nscb.gov.ph




                                                                                                             22
                                                                                                                Gains from other production sectors also boosted
Economic Performance
Growth rate (in percent)
                                                                                                                GDP. Industry and agriculture, fishery and forestry
                                                                             2007                       2006    (AFF) contributed 2.7 percentage points and 0.7
                            Sector
                                                                       Q2               Q1               Q2     percentage point, respectively, to total output
By industrial origin
                                                                                                                growth in Q2.
Agriculture, Fishery & Forestry                                        3.9              4.1             6.7
  Agriculture and Fishery                                           3.8                  4.0         6.9        Agricultural output grew by 3.9 percent in Q2 2007
  Forestry                                                         28.2                 23.1        -13.6       from 6.7 percent in the same period a year ago.
Industry                                                            8.0                  6.3         4.4
                                                                                                                Growth in AFF, which accounted for 16.6 percent of
  Mining and quarrying                                             33.3                 13.2            3.3
  Manufacturing                                                        3.7              4.0             4.2
                                                                                                                total GDP, was driven by the fishery, other crops
  Construction                                                     21.0                 20.0            4.0
                                                                                                                and palay subsectors. Palay continued to grow by
  Electricity, gas and water                                        5.8                  4.4            7.4     4.4 percent in Q2 2007 from 10.3 percent in the
Services                                                               8.4              8.8             5.7     previous year, due mainly to wider areas being
  Transport., Comm., & Storage                                         9.8              10.5            5.4     planted in Central Luzon, Eastern Visayas, Ilocos
  Trade                                                                8.4               8.8            5.0
                                                                                                                Region and SOCCSKSARGEN; sufficient irrigation
  Finance                                                          11.8                 14.8            10.0
  O. Dwellings & real estate                                           6.3              5.5             5.2
                                                                                                                water; and input subsidies from the Department of
  Private services                                                     8.6              8.4             5.4     Agriculture (DA)-GMA Rice Program which aided
  Government services                                                  2.8              2.3             4.9     farmers during the cropping period in Q2. Corn, on
                                                                                                                the other hand, declined by 2.5 percent in Q2 after
Source: NSCB
                                                                                                                posting a strong recovery in the same period last
                                                                                                                year. The decline was attributed to smaller planted
                                                                                                                areas in SOCCSKSARGEN, Northern Mindanao
Agriculture, Industry and Services Sectors                                                                      and Zamboanga Peninsula due to less rain in these
Annual Growth in Real Terms
                                                                                                                areas than in the previous quarter. Likewise, the
 15 .0
                                                                                                                harvesting period for both palay and corn was
 10 .0                                                                                                          moved from Q2 to Q1 in Cagayan Valley due to the
   5 .0
                                                                                                                early cropping phase. Meanwhile, increased fish
                                                                                                                catch from commercial fishing, brought on by
   0 .0
                                                                                                                favorable weather conditions, largely contributed to
  -5 .0                                                                                                         the sustained growth of fishery, which posted a 6.1
 -10 .0
                                                                                                                percent gain during the period.
 -15 .0
          1995   199 6   19 97   1 998   1999   2000    2001   200 2    20 03   2 004     2005
                                                                                            2005 2006    2007   Construction, manufacturing, and mining and
                    Agriculture                        Industry                     Services                    quarrying were the biggest contributors to industry
                                                                                                                growth. Mining and quarrying output surged by 33.3
                                                                                                                percent due to increased production of coal, nickel,
                                                                                                                crude oil, natural gas and             condensate.
                                                                                                                Manufacturing continued to expand although at a
                                                                                                                slower pace of 3.7 percent, led by food, beverages,
                                                                                                                non-metallic mineral products, metal industries,
                                                                                                                footwear, wearing apparel, and furniture and
                                                                                                                fixtures. Construction surged by 21.0 percent in Q2
                                                                                                                on the back of the 39.6 percent expansion in public
                                                                                                                construction.




                                                                                                                                                           23
Labor Market Conditions
Unemployment and underemploym ent rates                                                Based on the preliminary results of the July 2007
decline.                                                                               Labor Force Survey (LFS), the unemployment rate
                                                                                       declined to 7.8 percent in July 2007 from its year-
  Unemployment Rate
                                                                                       ago level of 8.1 percent. 12

 8.5                                                                                   There were 33.3 million Filipinos employed in July
                                                                                       out of approximately 36.2 million Filipinos in the
 8.0
                                                                                       labor force. Total employment grew by 1.2 percent
 7.5                                                                                   year-on-year.
 7.0
                                                                                       The services sector employed 49.9 percent of the
 6.5                                                                                   total employed population, while agriculture and
                                                                                       industry sectors accounted for 34.5 percent and
 6.0
         Q2       Q3      Q4    Q1     Q2          Q3      Q4    Q1       Q2      Q3   15.6 percent, respectively.
                 2 005                      2006                         2 007



                                                                                       The underemployment rate declined to 22.0 percent
                                                                                       in July 2007 from 23.4 percent in the same period
                                                                                       last year. Underemployed persons in the agriculture
                                                                                       sector accounted for 44.4 percent and the services
                                                                                       sector comprised 40.4 percent of the total
                                                                                       underemployed. 13

 II. M ONETARY AND FINANCIAL CONDITIONS

 Interest Rates

 Domestic interest rates increase in the third                                          The Government’s announcement of the higher-
 quarter.                                                                               than-programmed fiscal deficit for the first
                                                                                        semester drove up the rates of government
 91-day T-bill rate, BSP RRP rate and KBs Lending Rate                                  securities in the primary market starting in July.
 In percent
 20
                                                                                        The benchmark 91-day T-bill rate averaged higher
 18                                                                                     at 3.680 percent in Q3 2007 from 2.974 percent in
 16                                                                                     the previous quarter. Similarly, the average yield
 14
                                                                                        for the 182-day tenor also surged to 4.776 percent
 12
                                                                                        in Q3 2007 from 3.713 percent last quarter, while
 10

  8
                                                                                        the average rate for the 364-day tenor increased
  6                                                                                     to 5.530 percent from 5.174 percent in Q2 2007.
  4                                                                                     Nevertheless, these rates are still lower compared
  2
  2000         2001      2002   2003        2004        2005    2006       2007
                                                                                        to those of the previous year.
          91-day T-bill rate                        Overnight RRP Rate
          Bank Lending Rate (Low-end)




          12
              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 c urrently available for work, seeking work or not
          seeking work for valid reasons.”
          13
             Underemployed persons include all employed persons who express the des ire to have additional hours of work in their
          present job or an additional job, or to have a new job with longer working hours. Vis ibly underemployed persons are thos e
          who work for less than 40 hours during the re ference period and want additional hours of work. Invisible
          underemployment refers to individuals who are working in jobs where their skills are not adequate ly utilized (e.g. nursing
          graduate working as a bank teller).




                                                                                                                                  24
                                                                                                       The average bank lending rates rose to a range of
                                                                                                       7.6-7.9 percent in the second quarter, compared
                                                                                                       to the 7.4-7.5 percent range recorded in the
                                                                                                       previous quarter.

                                                                                                       Yield Curve

   Secondary market yield curve generally shifts                                                       As of 28 September 2007, the yield curve for
   downward.                                                                                           government securities in the secondary market
                                                                                                       generally declined compared to the yields
                                                                                                       registered at the end of the previous quarter.
        Yield of Government Securities in the Secondary Market
            In percent                                                                                 The yield curve shifted downward as bond prices
                   12
                                                                                                       recovered from lows recorded following 17 August,
                   11                                                                                  the height of the fallout in the US subprime
                   10
                                                                                                       mortgage sector.
Yield in percent




                    9
                    8
                    7
                                                                                                       On the domestic front, yields declined as bond
                    6
                    5                                                                                  prices rose with improved investor sentiment
                    4                                                                                  following the announcement of good fiscal
                    3
                    2
                                                                                                       numbers for Q3, lower inflation rates, and higher-
                        3Mo     6Mo   1Yr    2Yr    3 Yr      4Yr     5Yr   7Yr   10Yr   20Yr   25Yr   than-expected GDP growth rate. The cut in the
                                                           Maturity
                              end Sep 2007         end Jun 2007                                        target for the federal funds rate and, subsequently,
                              end Mar 2007
                                                                                                       markets’ anticipation of a cut in BSP’s policy rates
                                                                                                       also contributed to the rally in bond prices during
                                                                                                       the review period.




                                                                                                                                                  25
Before- and after-tax interest rate margins                                                                                                 Interest Rate Differentials
display mixed trends.
                                                                                                                                            The negative differentials between domestic and
    Interest Rate Differentials
                                                                                                                                            US T-bill rates narrowed during the quarter with the
    in basis points                                                                                                                         decline in the US 90-day T-bill rate. Similarly, the
 200                                                                                                                                        negative differentials between domestic interest
 150
                                                                                                                                            rates and US LIBOR generally narrowed during the
 100


    50
                                                                                                                                            quarter. Subsequently, these differentials slightly
     0                                                                                                                                      widened in the last month of Q3 as the US LIBOR
  -50


 -100
                                                                                                                                            increased.
 -150


 -200


 -250
                                                                                                                                            The differential between the BSP’s policy interest
 -300
                                                                                                                                            rate (overnight borrowing or RRP rate) and the
 -350
             Mar 06        Jun 06               S ep 06               Dec 06               Mar 07              J un 07        Sep 07
                                                                                                                                            target for the US federal funds rate narrowed from
                          91-day T-bil l vs US 90-day T-bill                              91-day T-bil l vs US 90-day LIBOR                 225 basis points in Q2 to 75 basis points in the
                          91-day T-bil l vs US 90-day T-bill                              91-day T-bil l vs US 90-day LIBOR
                                                                                                                                            first two months of Q3 but widened in September
                                                                                                                                            to 125 basis points following the 50-basis-point cut
    BSP RRP Rate and US Fed Funds Rate
                                                                                                                                            in the target for the US federal funds rate.
  In percent

8                                                                                                                                           Adjusted for the risk premium—which is measured
7                                                                                                                                           by the differential between the 10-year Republic of
6                                                                                                                                           the Philippines (ROP) note and the 10-year US
5                                                                                                                                           Treasury note—the differential between the BSP’s
4
                                                                                                                                            policy rate and the US federal funds target rate
3
                                                                                                                                            turned negative (-40 basis points) as of 26
2
                                                                                                                                            September 2007 compared to 82 basis points as of
1
                                                                                                                                            end-June 2007.
0
    2004                            2005                                  2006                                  2007


                          BSP RRP rate                                             US Fed funds rate




Real lending rate increases during the quarter.                                                                                             Real Lending Rate
     Average Real Lending Rates: Selected Asian Countries
    I n percent                                                                                                                              The real lending rate—measured as the difference
                                                                                                                                            between the median bank lending rate and
             India                                                                                                9.43
                                                                                                                                            inflation—rose to 5.5 percent in Q3 from 5.1
         Indonesia                                                                           7.31

     Hong Kong                                                                     6.15
                                                                                                                                            percent in Q2. This was due mainly to the rise in
          Thailand                                                             5.75
                                                                                                                                            Philippine bank lending rates. Among a sample of
    Philippines                                                           5.50                                                              10 Asian countries, the Philippines’ real lending
          Malaysia                                             4.44                                                                         ranked fifth highest.
  South Korea                                                  4.38

           Taiwan                            2.64

         Singapore                         2.43

            Japan                        2.25

                      0             2                     4                    6                    8                    10            12




                                                                                                                                                                                       26
Financial Market Conditions

Optimistic market sentiment and ample liquidity                  Investor sentiment in domestic financial markets
continue to fuel dem and for equities and                        continued to be buoyed in Q3 by improved
government securities.                                           macroeconomic          fundamentals—particularly
                                                                 prudent monetary policies, the favorable fiscal
                                                                 performance and ample liquidity in the financial
                                                                 system—which whetted the appetite for both
                                                                 equities and government debt instruments. 

Positive market sentiment continues to drive                     Stock Market
equity prices.
                                                                 Trading in the local bourse advanced in Q3 as the
                                                                 Philippine Stock Exchange Composite Index
 PSE Composite Index                                             (PSEi) averaged 3,479.8 index points in the
                                                                 second quarter, higher by 11.0 points than last
 4,000
                                                                 quarter’s 3,468.8 average PSEi. The PSEi closed
 3,500                                                           at 3,791.4 on 5 July 2007, the highest so far during
 3,000                                                           the year. Overall market sentiment was bullish as
                                                                 second quarter output growth remained robust.
 2,500
                                                                 Ample liquidity, a firm peso, and the easing of
 2,000                                                           domestic inflation also helped sustain investor
 1,500                                                           interest in the market. The stock market is
                                                                 expected to remain strong on expectations that the
 1,000
                                                                 country will post its highest growth in more than
  500
         2000   2001   2002   2003   2004   2005   2006   2007
                                                                 three decades this year.




                                                                                                            27
                                                                            Government Securities

 BTr auctions for GS continue to be                                         The appetite for T-bills remained healthy as
 oversubscribed.                                                            auctions by the Bureau of the Treasury (BTr)
                                                                            continued to attract large volumes of bids in Q3.
 Oversubscription of T-bill Auctions                                        The NG’s debt securities were oversubscribed as
 In billion pesos
                                                                            tenders totaled P77.7 billion compared to the
140
                                                                            P32.0 billion total offering. Oversubscription for the
120                                                                         six T-bill auctions during the quarter was higher at
100                                                                         P45.7 billion compared to the P37.6 billion posted
 80
                                                                            in the previous quarter. Meanwhile, average
 60
                                                                            monthly oversubscription during the quarter was
                                                                            higher at P7.6 billion compared to P6.3 billion in
 40
                                                                            the previous quarter.
 20


  0
      2000        2001   2002   2003   2004    2005   2006    2007


                                                                            Sovereign Bonds and CDS Spreads

The difficulties in the US subprime mortgage and                            The reverberations from the US subprime
credit markets affect Philippine soverign and CDS                           mortgage market meltdown, which caused a sharp
spreads.                                                                    sell-off in credit and equity markets in major
                                                                            markets around the world, were reflected in the
                                                                            widening of Philippine sovereign bond spreads
                                                                            during the quarter. The spreads of ROP 2015
                                                                            bonds over the benchmark 10-year US Treasury
                                                                            notes and CDS 14 widened significantly in Q3
                                                                            relative to the previous quarter. The ten-year ROP
                                                                            and CDS spreads in Q3 widened to 186.4 basis
                                                                            points and 162 basis points, respectively, from the
                                                                            128.6 basis points and 106 basis points recorded
                                                                            in the previous quarter.

                                                                            Sovereign bond and CDS spreads have since
                                                                            narrowed starting in late August following the
                                                                            Fed’s cuts in both its discount rate and the target
                                                                            for the federal Funds rate in September.




             14
               A credit default s wap (CDS) is a bilateral contrac t under which two counterparties agree to is olate and separately trade
             the credit ris k of at least one third-party reference entity. Under a credit default swap agreement, a protection buyer pays
             a periodic fee to a p rotec tion seller in exc hange for a contingent payment by the seller upon a credit event (such as a
             default or failure to pay) happening in the reference entity. When a credit event is triggered, the protec tion seller either
             takes delivery of the defaulted bond fo r the par value (phys ic al settlement) or pays the protection buyer the difference
             between the par value and recovery value of the bond (cash settlement). Credit default swaps are the mos t widely traded
             credit derivative product. The typical term of a credit default swap contract is five years, although being an over-the-
             counter derivative , credit default swaps of almost any maturity c an be traded.




                                                                                                                                      28
Banking System
                                  The country’s banking system continued to
                                  perform favorably during the period as the
                                  sustained implementation of financial sector
                                  reforms continued to bear fruit. The improving
                                  macroeconomic conditions likewise provided an
                                  encouraging environment for banks to further
                                  strengthen their balance sheets and improve
                                  profitability. Key performance indicators reflected
                                  overall soundness as shown by the sustained
                                  growth in bank lending and the remarkable
                                  improvement in bank asset quality, with NPL ratio
                                  nearing pre-crisis level. Likewise, banks remained
                                  adequately capitalized in spite of higher loss
                                  provisioning levels and stricter alignment of capital
                                  requirements with international standards.



                                 Savings Mobilizat ion

                                 The banking system’s deposit liabilities as of end-
Banks’ deposit base increases.
                                 June 2007 continued to grow robustly, posting an
                                 increase of 13.6 percent to P3.6 trillion from its year
                                 ago level of P3.2 trillion. Demand and time deposits
                                 sustained year-on-year growths at 33.9 percent and
                                 19.3 percent, respectively. Savings deposits, which
                                 continued to account for half of the banks’ funding
                                 base, similarly increased by 4.7 percent relative to
                                 its level a year ago. Compared to the end of the
                                 previous quarter, the banking system’s deposit
                                 liabilities increased modestly by 0.6 percent.




                                                                               29
                                    Lending Operations

Growth in bank lending continues.   Outstanding loans of commercial banks, thrift banks
                                    and rural banks (net of reverse repurchase or RRP
                                    placements) expanded by 7.5 percent year-on-year
                                    in August compared to 4.7 percent in June. This
                                    was a marked turnaround from the 0.4 percent
                                    decline registered in the same month a year ago.

                                    Most sectors of the economy registered an uptrend
                                    in lending growth, led by the transportation, storage
                                    and communication sector at 15.4 percent, followed
                                    by the construction sector at 11.9 percent, and the
                                    community, social and personal services sector at
                                    11.5 percent. Lending to the wholesale and retail
                                    trade grew by 4.1 percent. Lending to financial
                                    institutions, real estate, and business services
                                    posted a modest growth of 6.4 percent, but, net of
                                    RRPs, a hefty 21.8 percent growth was recorded by
                                    this sector. Meanwhile, agriculture, fisheries and
                                    forestry (AFF) exhibited a modest deceleration in
                                    lending growth to 5.7 percent. By contrast, lending
                                    to mining and quarrying, manufacturing, and
                                    electricity, gas and water continued to post declines
                                    relative to their levels a year ago.

                                    Gross of banks’ RRP placements with the BSP,
                                    bank lending exhibited the same trend, rising by 4.3
                                    percent year-on-year in August from 3.4 percent in
                                    July.



Consumer loans increase.            Meanwhile, the combined credit card receivables
                                    (CCRs) of universal and commercial banks (U/KBs)
                                    as well as thrift banks as of end-June 2007
                                    increased by 24.6 percent year-on-year to reach
                                    P102.0 billion, and by 5.8 percent compared to the
                                    end of the previous quarter’s level of P96.4 billion.
                                    The ratio of CCRs to the total loan portfolio (TLP)
                                    increased to 5.4 percent from 4.5 percent as of end-
                                    June 2006. Of the total CCRs, 13.8 percent was
                                    past due, slightly lower than the 14.2 percent
                                    recorded at end-March 2007.




                                                                                30
    Similarly, U/KBs’ and TBs’ combined auto loans as
    of end-June 2007 rose by 21.1 percent to P78.9
    billion from P65.2 billion in June 2006, and by 5.6
    percent from the end-March 2007 level of P74.7
    billion. Auto loans accounted for 4.2 percent of TLP
    and only 4.8 percent of total auto loans were past
    due.

    U/KBs' real estate loans (RELs) declined minimally
    by 0.6 percent to P192.2 billion from its year-ago
    level of P193.5 billion but increased by 4.2 percent
    compared to the previous quarter’s level of P184.5
    billion. RELs granted for the construction and
    development of real estate properties for
    commercial purposes including infrastructure
    projects held a vast share of 81.2 percent (or
    P156.2 billion) of total RELs while the remaining
    18.8 percent (or P36.0 billion) was granted for the
    acquisition of residential units by individual
    homeowners/borrowers.


 




                                               31
                                               Institutional Developments

Resources of the banking system rise.          The total resources of the banking system rose by
                                               9.5 percent to P5.082 trillion as of end-July 2007
                                               from its year-ago level of P4.641 trillion. The
                                               increase was due mainly to the rise in banks’
                                               deposits with the BSP and other banks,
                                               investments, and loans and discounts. Commercial
                                               banks (KBs) continued to account for almost 90
                                               percent of the total resources of the banking
                                               system.


Number of banks falls due to mergers and       The number of banking institutions (head offices)
consolidations   but  operating network        fell further to 858 as of end-June 2007 from the year
continues to expand.                           ago level of 871, reflecting continued consolidations
                                               and mergers, as well as the closure of weak banks.
                                               The total number of banking institutions was
                                               comprised of 38 KBs, 83 TBs and 737 rural banks
                                               (RBs). Meanwhile, the number of operating network
                                               of the banking system increased to 7,738 as of end-
                                               June 2007 from 7,693 at end-June 2006, reflecting
                                               mainly the increase in TBs’ and RBs’
                                               branches/agencies. On a quarterly basis, the
                                               number of banking institutions declined to 858 as of
                                               end-June 2007 from 861 as of end-March 2007.




Asset quality of banks continues to improve.   The asset quality of the banking system continued
                                               to improve as the non-performing loan (NPL) ratio
                                               was lower at 5.6 percent as of end-July 2007
                                               compared to 7.5 percent a year ago. The
                                               improvement in the NPL ratio was sustained due to
                                               the 20.4 percent drop in the level of NPLs,
                                               complemented by the 6.8 percent increase in the
                                               amount of the industry’s TLP. NPLs shrunk to
                                               P132.7 billion during the period under review from
                                               the previous year’s level of P166.8 billion, while TLP
                                               reached P2,363.6 billion from P2,212.1 billion.

                                               Meanwhile, the NPL ratio of U/KBs as of end-July
                                               2007 eased further by 2.0 percentage points to 5.2
                                               percent from 7.2 percent a year ago.




                                                                                            32
                                                              Compared with other countries in the region, the
                                                              Philippine banking system’s NPL ratio of 5.6
                                                              percent as of end-July 2007 was lower than
                                                              Indonesia’s 6.7 percent, but higher than Malaysia’s
                                                              3.6 percent, Thailand’s 4.8 percent, and Korea’s 0.8
                                                              percent.15 The lower NPL ratio in Malaysia,
                                                              Thailand, and Korea could be attributed in part to
                                                              the creation of publicly-owned asset management
                                                              companies (AMCs), which purchased the bulk of
                                                              their NPLs, a strategy not adopted in the
                                                              Philippines.

                                                              The loan exposure of banks was adequately
                                                              covered as the banking system’s NPL coverage
                                                              ratio remained high at 76.3 percent as of end-July
                                                              2007, reflecting banks’ diligent compliance with the
                                                              loan-loss provisioning requirements.



Capital adequacy ratio remains higher relative                Using the new risk-based framework, banks
                                                              remained adequately capitalized as of end-March
to BSP and international standards.
                                                              2007, with the industry’s capital adequacy ratio
                                                              (CAR) at 17.5 percent on a solo basis and 18.8
                                                              percent on a consolidated basis. However, these
                                                              ratios were lower than the previous year’s levels of
                                                              18.0 percent and 19.4 percent on solo and
                                                              consolidated basis, respectively, but higher than the
                                                              end-December 2006 CARs of 16.8 percent and
                                                              18.1 percent on solo and consolidated basis,
                                                              respectively. The industry’s CAR continued to
                                                              exceed the statutory level set by the BSP at 10.0
                                                              percent and the Bank for International Settlements’
                                                              (BIS) standard at 8.0 percent. This is reflective of
                                                              the banking system's ability to cover risky assets.

                                                              The Philippines’ CAR remains comparatively higher
                                                              than those of Thailand (12.8 percent), Malaysia
                                                              (12.9 percent), and Korea (13.0 percent). Indonesia
                                                              posted the highest CAR in the region at 22.1
                                                              percent.16




     15
       Sources: Various central bank websites. Thailand (KBs, May 2007); Malaysia (KBs , August 2007); Korea (KBs,
     Dec ember 2006); and Indonesia (KBs , May 2007)
     16
       Sources: Various central bank websites, Thailand (KBs, June 2007); Malaysia (KBs, August 2007); Korea (KBs , March
     2007); and Indones ia (KBs, April 2007).




                                                                                                                     33
Placements under the BSP’s SDA facility                   SDA placements rose by P411.7 billion to P461.4
increase.                                                 billion as of end-September 2007 from last year’s
                                                          level of P49.7 billion. The significant increase in
                                                          SDAs could be attributed to the recent monetary
                                                          measures that were implemented on 10 May
                                                          2007.17 Meanwhile, the total volume of banks’
                                                          placements with the BSP under the RRP window
                                                          amounted to P206.1 billion as of end-September
                                                          2007, lower by P16.4 billion than its year-ago level.




     17
       For a thorough dis cussion of the monetary meas ures implemented on 10 May 2007, please see the section on
     Moneta ry Policy Developments .




                                                                                                             34
    Exchange Rate
    The peso continues to appreciate against the US The peso appreciated by 8.9 percent against the
    dollar.                                                          US dollar as of 28 September 2007 vis-à-vis its
                                                                     end-2006 level. On a quarterly basis, the peso
                                                                     appreciated by 2.2 percent to average P45.94/US$1
                                                                     in Q3 2007 from P46.93/US$1 in the previous
                                                                     quarter.18 The peso proved resilient amid the rise in
     Daily Peso S Dollar Rate
               -U                                                    risk aversion against emerging market assets,
        P/US$
     60                                                              which was tied to fears of a global credit tightening
                                                                     stemming from banks’ and other financial
     55                                                              institutions’ soured exposure to the US subprime
                                                                     mortgage market. Nonetheless, the sustained
     50
                                                                     strength of dollar inflows from OF remittances,
     45
                                                                     export earnings and foreign investments continued
                                                           end-S
                                                          P45
                                                                 ep
                                                             .94/US$
                                                                     to boost the peso, which reached a seven-year
     40
                                                                     high of P44.79/US$1 on 25 July 2007. Moreover,
                                                                     the provision by major central banks of additional
     35                                                              liquidity as well as the reduction by the US Federal
      2000        2001     2002 2003 2004   2005   2006     20 07
                                                                     Reserve of its discount rate to 5.25 percent along
                                                                     with the target for its federal funds rate by 50 basis
                                                                     points to 4.75 percent to avert possible adverse
           Changes in Selected Dollar Rates                          effects on real sector activity, helped tame the
                                          Appr./Depr. (-)
                                                                     growing risk aversion in emerging market assets.
                                             Year-to-date
                                        28 Sep 07 29 Jun 07              Most regional currencies tracked an appreciating
                                                                         path, with the exception of the Indonesian rupiah
       Philippine peso                     8.86      6.03
                                                                         and New Taiwan dollar, which depreciated against
       Thai baht                           12.36    2.66                 the US dollar on a year-to-date basis.
       Chinese yuan                        3.95      2.47
       Malaysian ringgit                   3.41      2.14                Volatility, as measured by the standard deviation of
       South Korean won                    1.64      0.68                the daily exchange rates, declined to P0.61 in the
       Singaporean dollar                  3.19     0.39
                                                                         third quarter of 2007 from P0.79 in the second
       New Taiwan dollar                  -0.22     -0.82
                                                                         quarter, reflecting less volatility in the peso-dollar
                                                                         exchange rate during the review quarter compared
       Indonesian rupiah                  -1.67     -0.51
                                                                         to that in the previous quarter.
       Japanese yen                        3.31     -3.56




          18
               Dollar rates or reciprocal of the peso-dollar (reference) rates were used to compute for the percent changes.




                                                                                                                               35
                                                         On a real, trade-weighted basis, the peso lost some
                                                         external price competitiveness in the third quarter
                                                         against the basket of currencies of major trading
                                                         partners (MTPs) as well as against the baskets of
                                                         currencies of competitor countries in the narrow and
                                                         broad series. This development, brought about by
                                                         the combined effects of the nominal appreciation of
                                                         the peso and the widening price differential across
                                                         the three currency baskets, translated to an
                                                         increase of the real effective exchange rate (REER)
                                                         of the peso by 2.0 percent against the basket of
                                                         currencies of MTPs and by 3.8 percent and 6.0
                                                         percent against the baskets of currencies of the
                                                         narrow and broad series of competitor countries,
                                                         respectively. 19

                                                         In view of the Philippines’ robust macroeconomic
                                                         fundamentals, which continue to buoy investor
                                                         confidence in the country, the peso is expected to
                                                         remain firm for the rest of 2007 despite the risks
                                                         posed by the tightening of global liquidity conditions,
                                                         heightened risk aversion for emerging market
                                                         assets, and volatile oil prices. Robust dollar inflows
                                                         from OF remittances, portfolio and foreign direct
                                                         investments as well as exports receipts are seen to
                                                         further result in a firmer currency.




19
    The REER index repres ented the Nominal Effec tive Exc hange Rate (NEER) index of the pes o, adjus ted for price
diffe rentials with the countries whose currencies comprise the NEER index basket. The NEER index, meanwhile,
represented the weighted average exchange rate of the pes o vis-à-vis a basket of foreign currenc ies.




                                                                                                                36
Monetary Aggregates
Liquidity growth slows down.
                                                                  Domestic liquidity (M3) growth slowed down to
                                                                  14.9 percent year-on-year in August from 19.4
                                                                  percent in June 2007. 20 The continued slowdown
                                                                  in liquidity growth is seen to reflect the effect of
                                                                  monetary measures initiated by the BSP in May.
                                                                  Reflective of the strong external payments
                                                                  position, net foreign assets of banks continued to
                                                                  expand. Domestic liquidity growth was, however,
                                                                  tempered by the fall in net domestic assets, which
                                                                  declined by 4.6 percent in August from the growth
                                                                  of 3.8 percent posted in June. The growth of credit
                                                                  to the public sector accelerated to 15.6 percent in
                                                                  August (from 10.5 percent in June), while the
                                                                  growth of credit to the private sector reached 7.3
                                                                  percent from 6.0 percent in June 2006. The Net
                                                                  Other Items account (which includes SDAs and
                                                                  RRPs), however, showed a large drop following
                                                                  the policy measures implemented by the BSP in
                                                                  May.


                                                                  Year-on-year growth in reserve money, a narrower
                                                                  measure of monetary aggregates, declined to 58
                                                                  percent as of end-September from 66 percent as of
                                                                  end-June 2007. 21




     20
            M3 refers to the stock of broad money based on data from the Depos itory Corporations Survey (DCS). The DCS,
     which replaced the Monetary Survey (MS) as the basis for measuring domestic liquidity, is an expanded list of s urveyed
     institutions that included the BSP, commerc ial banks, thrift banks, rural banks, non-stock savings and loan associations
     and non-banks with quasi-banking functions.
     21
            Reserve money (RM) is defined as the sum of currenc y issue net of cash in vaults of the BTr and banks’ res erve
    balances with the BSP.




                                                                                                                          37
                             Box Article: THE US SUBPRIME MORTGAGE MARKET

I.        Background22

Subprime Mortgages

        Subprime mortgages are residential loans that do not conform to the criteria for “prime”
mortgages, and thus have a lower expected probability of full repayment based on the borrower’s credit
record, debt service-to-income (DTI) ratio, and/or mortgage loan-to-value ratio. These are
predominantly securitized in the form of mortgage-backed securities that are enhanced with
mechanisms (e.g., credit enhancements, mortgage insurance coverage) to prevent rising default rates
to creep into higher-rated collateralized debt obligations (CDO) tranches.23 A number of more
sophisticated securitized financing products were in fact found to have been linked to subprime
mortgages.

        Meanwhile, the growth of the US subprime mortgage market was facilitated by several legal
milestones (e.g., state imposition of interest rate caps on housing loans, tax deductible interest on
residential mortgages, legal provisions on automatic underwriting and securitization) instituted by the
US Government. These milestones collectively made subprime loans a preferred means of financing
home improvement and facilitated the substantial expansion in home ownership in the 90s.

What triggered the subprime mortgage market crisis

        Subprime lending growth was boosted by highly leveraged lending against a background of
rapidly rising house prices and a generally low interest rate environment in 2001-2005. Housing
affordability reached a point where a significant portion of borrowers were overstretching their finances
by purchasing risky “affordability products,” 24 many of which were backed by low-quality assets. In
particular, subprime loan approvals were made on the basis of expected collateral appreciation, with
less consideration given to the ability of the borrower to make the necessary mortgage payments.
Along with the relatively accommodative credit criteria set by some mortgage dealers, borrowers were
allowed to make interest payments alone, leaving the principal unpaid and the level of housing equity
low. Thus, when the US Fed increased policy rates amid steady housing prices, many overstretched
borrowers ended up defaulting on their loan payments as prepayment and refinancing options were not
feasible due to inadequate housing equity. The resulting rapid deterioration of 2006 subprime mortgage
loans subsequently led to a series of foreclosures.

       At the same time, strong market preference for higher-yielding securities (associated with
subprime mortgages) in 2005-06 may have led to more liberal underwriting standards. Lending
safeguards were relaxed as intermediaries profited primarily from loan volumes rather than from
ensuring loan quality.




     22
        Kiff, J. and P. Mills , July 2007. “Money for Nothing and Checks for Free: Rec ent Developments in US Subprime
     Mortgage Markets”. IMF Working Paper No. WP/07188.
     23
         A defining feature of CDOs is the tranching or splicing of credit risk. The risk of loss on the referenc e portfolio is divided
     into tranches of increasing seniority. Losses will firs t affect the “equity” or “first loss ” tranc he, next the “mezzanine”
     tranche, and finally the “s enior” and “super-senior” tranches. (“ Gibson, Michael S., Understanding the Risk of Synthetic
     CDOs”, Federal Res erve Board, July 2004.
     24
        Thes e products were mos tly adjus table-rate mortgages ( ARMs) which combine floating and fixed rates mortgages.
     About two-thirds of recent ARM originations were “2/28” hybrids , which were effectively two-year fixed-rate mortgage
     (FRMs) that convert to 28-year ARMs at the end of the second year.




                                                                                                                                   38
II.         Impact on Global Financial M arkets

On financial institutions

         The US subprime mortgage crisis affected mostly hedge funds, banks with subprime-specialist
subsidiaries, and a number of finance companies. Losses apparently appeared at the end of the
securitization chain among the holders of unrated and lower-rated mortgage-backed securities (MBS)
and equity and mezzanine tranches of CDOs. 25

        A number of hedge funds, particularly those specializing in lower-rated subprime asset-backed
securities (ABS) and CDOs, reported significant losses in the aftermath of the meltdown. Besieged by
withdrawals and margin calls, these hedge funds were forced to liquidate holdings and realize losses.
Among those that disclosed their losses were two hedge funds managed by Bear Sterns, a large
investment bank heavily exposed to subprime assets. This was followed by reported losses of funds
managed by prominent banks (i.e., Swiss bank UBS; German banks IKB Deutsche Industriebank and
Sachesen Bank; and French bank BNP Paribas) with similar exposures in the US subprime mortgage
market. Meanwhile, in the property finance sector, major residential mortgage lenders (i.e.,
Countrywide Financial Corporation, Luminent Mortgage, Thornburg Mortgage) struggled with liquidity
problems as delinquency rates of borrowers deteriorated.

        As the US subprime market corrected in mid-August and market liquidity dried up in the periods
following the meltdown, a gradual correction in key markets in Europe ensued---with the impact
extending across the Atlantic and East Asian markets.

On major central banks

          To temper the effects of the mortgage meltdown, the US Federal Reserve Board immediately
put in place a number of policy measures to ease market concerns. First, the Federal Reserve pumped
in some US$62 billion of liquidity in the banking system through its open market operations (via
repurchase agreements) on 9-10 August to assist home mortgage creditors in coping with short-term
liquidity needs.26 This was followed by a 50-basis-point cut in the discount rate to 5.75 percent
beginning 17 August. The Fed also lengthened the maturity profile of term financing (from overnight to
30 days) and announced that it will “continue to accept a broad range of collateral for discount window
loans, including home mortgages and related assets, while maintaining existing collateral margins.” 27




      25
           Ibid.
      26
           Bloomberg, 10 August 2007; Temporary Open Market Operations, FRB,NY
      27
           US Federal Reserve Press Release, 17 August 2007




                                                                                               39
        While the Fed’s initial moves resulted in a wave of recovery among major stock markets, credit
woes dominated market sentiments in the US. This prompted the Fed to pump in additional liquidity to
the banking system to keep credit markets from drying up. For the period 9 August-6 September alone,
an estimated US$162 billion worth of funds were injected into the system through the reserve market.
Subsequently on 18 September 2007, the Federal Open Market Committee decided to lower its target
for the federal funds rate by 50 basis points to 4.75 percent. Discount rates were correspondingly
reduced further by 50 basis points to 5.25 percent. The Fed announced that the rate cut was intended
to “help forestall some of the adverse effects on the broader economy that might otherwise arise from
the disruptions in financial markets.”

         Since the financial correction, central banks around the world have also taken coordinated
efforts to increase liquidity in their respective markets to stabilize foreign exchange rates and prevent
contagion from escalating. After the 50-basis-point cut in the Fed rate on 17 August, the European
Central Bank (ECB) joined the Bank of Japan and the Reserve Bank of Australia in pumping further
cash into their respective financial systems. Meanwhile, the Bank of England lent some US$628 million
at its penalty interest rate (6.75%) for the first time in more than a month on 20 August.28

On equities markets

         At the height of the meltdown, major stock markets have experienced broad sell-offs and
experienced record drops in stock values in years as investors fled the effects of the US subprime
mortgage market. Stocks worldwide have shed over 7 percent since hitting record highs in July.29 Asian
stock markets experienced heavy sell-offs with dramatic falls of more than 5 percent in some bourses
as the fallout in the US credit markets drove investors to unload risky assets and flee to safe havens
such as bonds. On 16 August 2007, Korea’s KOSPI led the region’s decline with a 6.9 percent drop in
its index followed by the Philippines and Indonesia both shedding around 6 percent. Elsewhere around
the region, China, Singapore, Malaysia, Thailand, and Hong Kong posted more than 3 percent losses
in their stock market indexes.

          Percent Change of Selected Stock Market Index

                                                                            Monthly Percentage Change               Daily Percentage Change
                                                                            End-June        End-July    14-Aug-07    15-Aug-07 16-Aug-07 17-Aug-07
          China               Hang Seng Mainland Composite Index              5.52           6.49          0.53        -2.87     -3.29     -1.38
          China 'A' Shares    Shanghai Stock Exchange Composite Index         -7.03         17.02          1.09        -0.06     -2.14     -2.28
          China 'A' Shares    Shenzhen Composite Index                        -3.07         21.15          1.46        -0.18     -1.65     -2.27
          Japan               TOPIX Index (Tokyo Stock Price Index)            1.09         -3.87          0.30        -2.64     -1.67     -5.55
          South Korea         KOSPI                                            2.51         10.88         -1.70          -       -6.93     -3.19
          Singapore           Straits Times Index                              1.06         -0.02          0.18        -3.35     -3.70     -0.68
          Indonesia           Jakarta Stock Price Index                        2.64          9.79         -1.94        -6.44     -5.94        -
          Australia           Australian Stock Exchange 200 Index             -0.61         -2.08         -0.78        -2.96     -1.32     -0.71
          Malaysia            Kuala Lumpur Stock Exchange Composite Index      0.56          1.43          0.06        -2.83     -3.53     -1.33
          New Zealand         New Zealand Exchange                            -1.58         -0.50         -0.11        -1.51     -1.16     -1.61
          Philippines         Philippine Stock Exchange Composite Index       5.36          -4.36         -0.11        -4.08     -6.01     -1.97
          Thailand            Bangkok SET Index                                5.34         10.68         -1.37        -2.51     -3.00      1.03
          Hong Kong           Hang Seng Index                                  5.52          6.49          0.53        -2.87     -3.29     -1.38
          US                  Dow Jones Industrial Average                    -1.61         -1.47         -1.57        -1.29     -0.12      1.82
          Source: Bloomberg




     28
          “IMF Global Markets Monitor”, 21 August 2007
     29
          IMF Ex ternal Relations Department Morn ing Pres s, 10 Augus t 2007




                                                                                                                                            40
        Major markets however took a more solid turn following the US Fed rate cut on 18 September.
In the US, Wall Street drove to its best one-day performance ever with the S&P closing 2.9 percent
higher at 1,519.8 index points. In Europe, the U.K. benchmark FTSE 100 rose 2.1 percent to 6,415.3
while Germany's Dax gained 1.9 percent to 7,716.2 and France's CAC-40 climbed 2.4 percent to
5,682.0. In Asia, Japan's benchmark Nikkei 225 stock index soared by 579.7 points, or 3.7 percent, to
close at 16,381.5 points, marking its biggest point gain in more than five years. Hong Kong's Hang
Seng index jumped 977.8 points, or 4.0 percent, to 25,554.6. The Korea Composite Stock Price Index
rose 64.0 points, or 3.5 percent, and closed at 1,902.7. New Zealand's NZX-50 index rose 54.1 points,
or 1.3 percent, to 4,177.7, while Australia's Standard & Poor's (ASX 200) jumped 154.0 points, or 2.5
percent, to 6,362.0.30

On foreign exchange markets

         Asian currencies tumbled in August as stocks collapsed and investors cut their exposures to
riskier assets. As of 17 August 2007, the Indonesian rupiah took the biggest hit, dropping by 4.8
percent on a year-to-date basis followed by the South Korean won weakening by 2.1 percent and the
New Taiwan dollar by 1.3 percent. The Philippine peso, Thai baht, Indian rupee, Malaysian ringgit, and
Singaporean dollar likewise depreciated following the continued gains posted during the first half of
2007.


                                          Movements of Selected Asian Currencies
                  Currencies          2002    2003    2004    2005     2006   2007 1   2007 2   2002-2007 2
           South Korean Won            9.9     0.2    14.5      2.2     8.7    -2.1      1.4       36.9
           Thai Baht                   2.8     8.8     1.4     -4.9    13.9     6.1     12.7       34.7
           Singaporean Dollar          6.4     2.1     4.2       -2     8.6     0.1     4.9        24.2
           Indian Rupee                0.6     5.2       5     -3.5     1.8     6.8     12.4       21.5
           Philippine Peso            -2.7    -4.2     -1.4       6     8.3     4.7     10.6       16.6
           Indonesian Rupiah          16.5     5.4     -9.4    -5.8     9.3    -4.8     -0.7       15.3
           Japanese Yen                9.7    10.8      3.9     -13     -1      2.7      2.0       12.4
           Malaysian Ringgit            0       0        0      0.5     7.3     0.5      4.3       12.1
           Chinese Yuan                 0       0        0      2.6     3.4     2.9      3.9        9.9
           New Taiwan Dollar           0.9     2.2     6.3     -3.6     0.9    -1.3     -0.3        6.4
           1
             as of 17 August
           2
             as of 16 October

        Signs of leveraged trades were also seen unwinding, particularly among investors in the yen-
financed carry trades. This was prompted by the yen rising to a near-five-month high against the dollar
and the euro as investors who had borrowed the low-interest rate currency to buy riskier but higher-
yielding assets continued to unwind their positions.

         However, with the cut in the target for the US federal funds rate in September, currencies in the
region rallied against the US dollar. The Indonesian rupiah and Philippine peso led gains in Asia as the
cut in U.S. interest rates eased concerns that the global economy will slow down, boosting demand for
riskier assets. All 17 currencies of the region's largest economies, except for Indonesia and the New
Taiwan dollar, have recovered against the dollar as of 16 October 2007.




     30
          Bloomberg, 19 September 2007.




                                                                                                        41
III.   Impact on the Local Financial M arkets

       In the Philippines, local markets experienced some degree of volatility mainly due to rising risk
aversion but subsequently showed signs of gradual easing beginning in September.

       Equities and capital market. The local equities market experienced a dramatic decline in
share prices as the market’s main composite index dropped by 22.4 percent from a high of 3,791.4
index points on 5 July 2007 to 2,884.3 index points on 17 August 2007. The sustained selling in the
PSE saw the bourse lose its accumulated gains in 2007. Correspondingly, returns on equity and dollar-
denominated bond exposures of most local UITFs and mutual funds were affected with the degree of
impact varying across different funds.

         Since then, the market has managed to recover as investor sentiment improved following the
cut in the discount rate made by the US Federal Reserve in August. In addition, positive domestic news
such as reports of a robust second quarter GDP growth data (7.5 percent) and higher corporate
earnings led the PSEi to close the month at 3,365.3 index points.

                                             P h i lip p in e C o m p o s ite In d e x
                                                        2 0 0 5 to S e p t e m b e r 2 0 0 7
                                                        2        o           m
                                 4 ,0 0 0

                                 3 ,5 0 0

                                 3 ,0 0 0
                  Index Points




                                 2 ,5 0 0

                                 2 ,0 0 0

                                 1 ,5 0 0

                                 1 ,0 0 0
                                        J -0 6      M     M      J     S            N   J -0 7   M   M   J   S
                                            200 5                                       2 006
                                                                           P e r io d




          In September, the local bourse closed at 3,475.8 index points, relatively higher than the
previous month’s level. The positive turnaround was due to favorable developments both in the external
and domestic sectors, namely: the half-percentage-point cut in the discount rate for the second time in
a little over a month; and the higher-than-expected half-percentage-point cut in the target for the US
federal funds rate; the fiscal surplus achieved by the National Government for the third consecutive
month; the ADB’s growth forecast upgrade for the Philippine GDP, and the possibility of the BSP’s
doing a similar move as the US Fed. The resolution of the plunder charges against former President
Estrada also provided a welcome relief to investors, further boosting their confidence in the market.




                                                                                                                 42
        Exchange rate. The slowdown in capital flows and negative investor sentiment towards
emerging markets generally brought down the value of the peso against the US dollar in mid-August.
From a high closing rate of P44.79/US$1 on 24 July, the peso depreciated to P46.86/US$1 on 17
August.

         The peso continued to trade on the downside in early September to hit a low of P46.94/US$1
on 11 September as the market remained uncertain about the outcome of the Estrada plunder case.
Market jitters prompted investors to unload regional currencies and shift away from the perceived
riskier assets of emerging markets amid fears of a global credit tightening. But after the 18 September
Fed cuts, the peso firmed up again. The continued stream of remittances from OFs as well as dollar
earnings from exports also supported the peso. As of 16 October 2007, the peso was traded at
P44.34/US$1.
                                                      E n d - M o n t h C l o s i n g P e s o /U S D
                                                       E x c h a n g e R a t e a n d V o la tility
             5 8                                                                                                                                                                                                    0 .7 0
                                                                                      S t a n d a r d       D e v ia t io n       ( r h s)                       P e so / U S $          ( lh s )

             5 6                                                                                                                                                                                                    0 .6 0


             5 4                                                                                                                                                                                                    0 .5 0


             5 2                                                                                                                                                                                                    0 .4 0


             5 0                                                                                                                                                                                                    0 .3 0


             4 8                                                                                                                                                                                                    0 .2 0


             4 6                                                                                                                                                                                                    0 .1 0
                                                                                                                                                         P 4 6 .9 9 9
                                                                                                                                                         A s o f 3 O c t. 2 0 0 7
             4 4                                                                                                                                                                                                    0 .0 0
                       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      A       S   O
                                    2 0 0 5                                                                    2 0 0 6                                                                       2 0 0 7




         Interest rate spreads. The impact of the August global financial market downturn on the
Philippines was felt almost immediately on 17 August following the sharp fall in US equities at the
height of the US subprime mortgage problem. However, since the US Federal Reserve’s cut in the
discount rate on 18 August and the cut in the target for the federal funds rate on 18 September,
sovereign and CDS spreads have narrowed, with the global markets appearing to have largely set
aside worries about the credit market. Investors moved back to stocks at the start of the fourth quarter
as the market was encouraged that the worst might be over from the August’s credit and stock market
turmoil.

         E m e rg in g M a rk e ts B o n d s In d e x S p re a d                                                         C r e d i t D e fa ult S w ap o f Ph ili ppi ne S o ve r e ig n B o nd
                J an u a ry – 1 6 O c to b e r 2 0 0 7                                                                                     J an ua ry – 1 6 O c to be r 2 007

   250                                                                                                                        250
                           E M BI + P hilip p ine s s p re a d
   225                                                                                                                        200
                           E M BI + sp re ad
   200
                                                                                                                              150
   175
                                                                                                                              100
   150                                                                        W id e nin g p re s su re o n
                                                                              r e ne w e d co nc e rn s on US                      50
   125                                                                        s u bp rim e m ort ga g e
                                                                              c r is is .
   100                                                                                                                               0
         J         F       M            A         M           J           J           A          S            O                              J       F       M           A           M              J           J        A   S    O




                                                                                                                                                                                                                                 43
       With the dissipating credit worries, EMBI+ Philippine spreads, narrowed to 155 basis points on
12 October from a high of 241 basis points on 10 September. Philippine CDS spreads likewise
narrowed to 121 basis points on 11 October from a September-peak of 191 basis points. However,
widening pressures became apparent on 15 October on renewed concerns that the US subprime
mortgage crisis could drag on at least through 2008, which could expose emerging markets to greater
risks.

       It may also be noted that Philippine banks reported very minimal exposures in structured
products such as collateralized debt obligations (CDOs) and credit-linked notes (CLNs), none of which
have underlying assets that are credit risky like subprime mortgages in the US.

IV.    Overall Assessment

        On the whole, the impact on the broader Philippine economy of higher investor risk aversion
has been relatively small and largely indirect. To a large extent, this could be attributed to the sound
macroeconomic fundamentals of the country (i.e. solid output growth, low inflation, and strong external
payments position). Past fiscal and financial sector reforms also contributed in strengthening the
economy’s ability to withstand shocks. Notwithstanding the limited effect of the crisis, the BSP stands
ready to take pre-emptive measures to bolster confidence amid the uncertainties in the financial
market. It will keep the confidence of the financial markets solid behind adherence to macroeconomic
prudence and sustained financial sector reforms. The BSP also continues to monitor closely the
situation so that threats to the stability of the financial system could be addressed promptly.




                                                                                                44
 Fiscal Developments
                                                                                  The January-September deficit of the NG reached
 Fiscal balance continues to improve.                                             P40.0 billion, 25.4 percent lower than the deficit of
National Government Fiscal Performance                                            P50.4 billion incurred during the same period last
January-September 2007                                                            year. For the first nine months, revenue collections
In billion pesos                                                                  grew by 13.5 percent to P812.3 billion compared to
                                                                                  P715.9 billion for the same period last year. Of this
                         January-September    Percent   Q1-Q3 2007   Program vs   amount, the BIR and the Bureau of Customs (BOC)
                                              Change     Program     Actual (%)   contributed P521.9 billion and P153.0 billion, as
                         2007        2006
                                                                                  their collections grew by 8.6 percent and 4.9
Surplus/(Deficit)         -40.0       -50.4      20.6       -54.0        74.1     percent, respectively. The Bureau of the Treasury
Revenues                 812.3        715.9      13.5       837.0        97.0     (BTr) also contributed P57.2 billion, while other
                                                                                  offices, including the sale from privatization
Expenditures             852.3        766.3      11.2       891.0        95.7
                                                                                  registered an income of P80.2 billion.
Source: BTR
                                                                                  Total disbursements during the same period
                                                                                  amounted to P852.3 billion, 11.2 percent higher
                                                                                  than the comparable disbursements in 2006.
                                                                                  Excluding interest payments, total disbursements
                                                                                  increased by 23.0 percent to P629.6 billion.
                                                                                  Interest payments declined by 12.5 percent to
                                                                                  P222.7 billion.




                                                                                                                              45
III. External Developments

The global economy continues to grow, but     The global economy continued to grow in Q2.
growth is expected to slow down in the near   Growth was mainly supported by buoyant economic
term .                                        activity in emerging markets. However, risks to the
                                              global economic outlook have increased recently,
                                              mainly because of the subprime mortgage problem
                                              in the US, indicating a possible slowdown in the
                                              near term. Nevertheless, economic prospects in the
                                              Euro area and Japan remained positive—as these
                                              countries registered modest output growth in Q2—
                                              while China and India continued to play increasingly
                                              significant roles as drivers of global economic
                                              growth. Global financial markets have stabilized
                                              after the 18 September 2007 Fed meeting, when
                                              the target for the federal funds rate was cut by 50
                                              basis points. Subsequently, global equities have
                                              recovered and global credit spreads have
                                              narrowed. Meanwhile, the risk of rising global
                                              inflationary pressures remained due to increasing
                                              resource utilization, capacity constraints, and rising
                                              global commodity prices.


The US economy continues its expansion        Revised Q2 2007 US GDP indicated that the US
despite persistent weakness in the housing    economy grew by 3.8 percent, its fastest pace since
sector.                                       Q1 2006, despite the persistent weakness in the
                                              housing sector. This was brought about by strong
                                              business investment, particularly spending on
                                              nonresidential structures. These offset the
                                              slowdown in consumer spending as well as the
                                              decline in residential investments.

                                              However, economic indicators point to downside
                                              risks in the near term. The housing slump turned
                                              out to be deeper than expected, with recent housing
                                              data as well as forward-looking indicators pointing
                                              to further declines in the coming months as
                                              mortgage disruptions work their way through the
                                              housing market. The deeper housing slump coupled
                                              with diminished equity wealth effects also suggest
                                              weaker consumer spending going forward.




                                                                                           46
                                                            The consumer confidence index, which recovered
                                                            in Q2, gave back all its gains in Q3, with the
                                                            September figure hitting its lowest level in two
                                                            years. Weaker business conditions, as a result of
                                                            the subprime mortgage housing market problems,
                                                            combined with less favorable labor market
                                                            conditions continue to dampen consumer sentiment
                                                            and heighten uncertainty and concern. Economic
                                                            activity in the manufacturing sector was generally
                                                            stable, but expanded at a slower rate in Q3
                                                            compared to the previous quarter.


                                                            Meanwhile, the decline in non-farm payroll
                                                            employment in August prompted the Fed to ease
                                                            monetary policy settings in its latest meeting in
                                                            September, to prevent the risks from the subprime
                                                            mortgage meltdown from spreading to the real
                                                            economy.

                                                            The financial markets stabilized during the week of
                                                            the Fed meeting on 18 September 2007. In
                                                            particular, US equities gained, as reflected in the
                                                            rebound of the S&P 500 while credit spreads
                                                            generally tightened, and demand for Treasury bills
                                                            increased. However, signs of distress are still
                                                            present in other areas, such as the asset-backed
                                                            commercial paper market. On balance, however,
                                                            financial conditions seemed to have been relatively
                                                            calmer in the recent period. As of September 2007,
                                                            the market was pricing in a steady reduction in the
                                                            target for the federal funds rate to 4.25 percent by
                                                            May 2008.31


                                                            On the price front, headline and core inflation
                                                            continued to decline, but consensus forecasts
                                                            expected core inflation to increase gradually, with
                                                            tight labor and commodity markets, weak
                                                            productivity growth, and rising import prices.


Latest econom ic surveys confirm continued                  Euro area GDP grew by 0.3 percent in Q2 2007, a
favorable outlook for the Euro area.                        slowdown from the 0.7 percent growth in Q1 2007,
                                                            as decreases in new investments offset growth in
                                                            household consumption during the quarter.




    31
         Lehman Brothers, Weekly Global Ec onomic Monitor




                                                                                                       47
                                                   However, latest survey data for the industrial and
                                                   services sectors indicated that robust economic
                                                   activity in the Euro area will continue in Q3 2007. In
                                                   particular, the latest Purchasing Managers’ Index
                                                   (PMI) for the manufacturing sector remained well
                                                   above its historical average in August and thus
                                                   continued to support the view of positive growth in
                                                   this sector for the rest of the year. Industrial
                                                   production and construction have likewise displayed
                                                   a persistent growth momentum in August, led by
                                                   the strong economic expansion in Germany. On
                                                   household spending, Euro area consumer
                                                   confidence rose further in Q2, nearing its highest
                                                   level since 2000. This was boosted by the robust
                                                   labor market conditions in the region, with
                                                   unemployment rate falling to 6.9 percent in July and
                                                   August from 7.0 percent in Q2.

                                                   Despite the current volatility in financial markets,
                                                   analysts regard the outlook for the Euro area as
                                                   favorable, with growth likely to be sustained in the
                                                   next two years. This is supported by robust labor
                                                   market conditions, with the unemployment rate
                                                   falling to a 25-year low. Consequently, expectations
                                                   of stronger wage growth could follow, boosting
                                                   household income and consumption growth.32


                                                   On the price front, the Harmonized Indices of
                                                   Consumer Price (HICP) inflation estimate for
                                                   September was at 2.1 percent, higher than the 1.9
                                                   percent increase registered in June. Base effects
                                                   from the strong increases of energy-related
                                                   components last year contributed to the decline in
                                                   the year-on-year headline inflation for the month.
                                                   Looking ahead, inflation risks remained on the
                                                   upside, stemming largely from domestic factors,
                                                   particularly high resource utilization and strong
                                                   employment growth, which could lead to stronger-
                                                   than-expected wage growth.




32
     August ECB Mon thly Bulletin, “www.ecb.int”




                                                                                                48
The Japanese economy grows at a m odest                      Japan’s GDP during Q2 2007 expanded at a much
pace.                                                        slower annualized rate of 0.5 percent from 3.2
                                                             percent in Q1 2007. The Q2 performance was
                                                             supported by the increase in domestic consumption
                                                             and capital spending, which offset the nil
                                                             contribution of net exports to GDP. 33 However,
                                                             higher taxes and falling wages may temper Japan’s
                                                             domestic demand-driven recovery and reduce
                                                             inflationary pressures. Consumer confidence fell in
                                                             Q3, suggesting that consumer spending could
                                                             wane, thus underscoring the need for exporters and
                                                             manufacturers to fill up the gap to boost Japan’s
                                                             economic performance. Nonetheless, Japan’s
                                                             average unemployment rate in July and August was
                                                             at 3.7 percent, lower than the 3.8 percent in Q2.


                                                             With these developments in the domestic economy
                                                             and the tightening of global liquidity conditions, the
                                                             Bank of Japan (BOJ) left key policy rates
                                                             unchanged in its latest meeting on 19 September,
                                                             with the BOJ Governor highlighting the need “to
                                                             monitor the state of global financial markets and its
                                                             potential impact on global growth.”

Economic indicators in emerging Asia signal                  Emerging Asia continued to expand at a robust
continued strong growth.                                     pace in Q3 particularly in China. In China, real GDP
                                                             growth accelerated to 11.9 percent in Q2, the
                                                             fastest pace since Q4 1995. The main contribution
                                                             to growth came from domestic demand and
                                                             exports. In particular, the trade surplus continued to
                                                             widen, with the January to August 2007 surplus
                                                             increasing by 72 percent from the same period a
                                                             year ago.34 India’s growth momentum also
                                                             continued, with a more robust Q2 real GDP growth
                                                             of 9.3 percent from 9.1 percent in Q1. Rapidly
                                                             accelerating growth has put some strains on these
                                                             two economies. Although India‘s wholesale price
                                                             inflation has been on a downtrend, inflationary
                                                             pressures remained high in both China and India on
                                                             account of high food and manufacturing inflation as
                                                             well as rising oil prices.




    33
         “Japan GDP up by 0.1 perc ent in 2Q”, www.japaneconomynews.com
    34
          ECB Monthly Bulletin, October 2007, available at www.ecb.int.




                                                                                                          49
                                                  Overall, prospects are favorable in emerging Asia,
                                                  underpinned by steady growth from domestic
                                                  demand and growth from exports. However, the
                                                  uncertainty in the U.S. economy, as well as sudden
                                                  shifts in global risk appetite, continued to pose risks
                                                  to growth in the near term. Meanwhile, inflation
                                                  remained broadly stable in other large emerging
                                                  Asian economies but risks to the outlook remained
                                                  on the upside, brought about by the possibility of
                                                  further increases in oil prices.

Central banks show differing policy directions.   The Fed lowered its target federal funds rate during
                                                  the third quarter, but the reduction by 50 basis
                                                  points to 4.75 percent was bigger than expected.
                                                  This move came as developments in the financial
                                                  markets increased the uncertainty in the economic
                                                  outlook. The Fed also approved a further reduction
                                                  in the discount rate by 50 basis points to 5.25
                                                  percent to maintain the stability of the overnight
                                                  borrowing market.


                                                  Meanwhile, the BOJ voted to keep its
                                                  uncollateralized overnight call rate steady at 0.5
                                                  percent during its 4 October 2007 monetary policy
                                                  meeting, on the premise that the monetary
                                                  environment should be accommodative to ensure
                                                  price stability while achieving sustainable growth in
                                                  the medium to long term. Both the European
                                                  Central Bank (ECB) Governing Council and the
                                                  Bank of England's (BOE) Monetary Policy
                                                  Committee similarly decided to keep their policy
                                                  settings unchanged in their 4 October 2007
                                                  meetings. The ECB’s decision was based on the
                                                  perceived upside risks in the medium-term outlook
                                                  for price stability. Against the background of strong
                                                  fundamentals in the Euro area, the ECB, in its latest
                                                  monetary policy statement, stated that “…monetary
                                                  policy stance is still on the accommodative side
                                                  with, inter alia, money and credit growth vigorous in
                                                  the Euro area.” Meanwhile, the BOE based its
                                                  decision on the view that indicators of price
                                                  pressures remain somewhat elevated against the
                                                  backdrop of sustained output growth.




                                                                                                50
IV. Monetary Policy Developments

BSP maintains a neutral monetary policy                               The Monetary Board decided to maintain a neutral
stance.                                                               monetary policy stance by implementing two
                                                                      complementary moves during its policy meeting on
                                                                      12 July 2007. The tiering system on placements
                                                                      with the BSP was lifted and the BSP’s key policy
BSP Policy Interest Rates                                             interest rates were adjusted to 6.0 percent for the
In percent
                                                                      overnight borrowing or reverse repurchase (RRP)
18                                                                    rate and 8.0 percent for the overnight lending or
16                                                                    repurchase (RP) rate. The removal of the tiering
14
                                                                      scheme and the adjustment in interest rates were
                                                                      also applied to placements in the special deposit
12
                                                                      account (SDA) facility of the BSP.
10

 8                                                                    The Monetary Board considered this policy stance
 6                                                                    as neutral relative to future inflation and output. The
 4                                                                    Monetary Board believed that the neutral stance of
 2000        2001   2002    2003    2004     2005    2006      2007   monetary policy was appropriate given moderate
               Overnight RRP Rate          Overnight RP Rate          demand pressures, favorable supply conditions and
                                                                      manageable inflation expectations during the
                                                                      period. Moreover, the Monetary Board considered
                                                                      that neutrality will provide greater flexibility in
                                                                      monetary policy in the absence of clearer direction
                                                                      on potential risks to the inflation outlook, such as
                                                                      liquidity, wage pressures, and oil prices.

                                                                      During its subsequent policy meeting on 23 August
                                                                      2007, the Monetary Board decided to maintain the
                                                                      BSP’s key policy interest rates at 6.0 percent for the
                                                                      overnight borrowing or reverse repurchase (RRP)
                                                                      rate and 8.0 percent for the overnight lending or
                                                                      repurchase (RP) rate.


Monetary measures in May were effective in                            In its assessment of economic conditions, the
containing liquidity…                                                 Monetary Board noted that recent data suggested
                                                                      that the additional liquidity management measures
                                                                      implemented in early May 2007 have exerted the
                                                                      desired cooling effect on liquidity conditions.
                                                                      Meanwhile, there were indications that the tiering
                                                                      scheme that had been in effect since November
                                                                      2006 has had a beneficial impact on bank lending
                                                                      to the productive sectors of the economy. At the
                                                                      same time, the Monetary Board observed that the
                                                                      continued broadening of financial markets was an
                                                                      indicator that non-bank sources of financing were
                                                                      becoming increasingly available to the corporate
                                                                      sector, therefore reducing reliance on bank lending.




                                                                                                                    51
…but risks to the inflation outlook remain.                      Domestic liquidity growth remained a key policy
                                                                 concern during the quarter. Although domestic
                                                                 liquidity growth was observed to be decelerating, a
                                                                 resumption of high liquidity growth could eventually
                                                                 pose risks to inflation. In addition, volatility in oil
                                                                 prices remained a risk to the inflation outlook, due
                                                                 to tight global oil supply, the onset of the hurricane
                                                                 season which was an added threat to supply, and
                                                                 the growing demand for crude oil from China and
                                                                 the US.35 The possibility of additional wage
                                                                 adjustments also provided some upside risks.

                                                                 The BSP will continue to be closely attentive to
                                                                 domestic       price   developments      and     the
                                                                 developments in the global economy. The Board
                                                                 will also remain watchful of any emerging risk to
                                                                 future inflation to ensure stable prices, which is a
                                                                 precondition to robust and durable economic
                                                                 growth.




     35
          Short-Term Energy and Winter Fuels Outlook, Energy Information Administration (EIA), 9 Oc tober 2007 release.




                                                                                                                          52
V. I NFLATION OUTLOOK

Inflation Forecasts
Emerging baseline forecast indicates                             The inflation outlook over the policy horizon was
generally benign inflation; but risks to the                     more benign in this assessment compared to the
inflation outlook remain, even as they have                      previous report. The lower actual inflation coupled
moderated.                                                       with the significant deceleration of liquidity growth
                                                                 and a firmer peso accounted for the downward
                                                                 revision in the baseline forecast. In addition, a lower
                                                                 path for LIBOR was assumed following the recent
                                                                 cut in the target for the US federal funds rate.36


                                                                 Favorable supply of food due to normalizing
                                                                 weather conditions and well-anchored inflation
                                                                 expectations also helped explain the subdued
                                                                 inflation environment amid the modest upward trend
                                                                 of demand-side indicators. The current baseline
                                                                 forecast also takes into account the impact of the
                                                                 possible occurrence of the La Niña weather
                                                                 phenomenon during Q4 2007.

                                                                 Dem and Conditions

                                                                 Demand conditions have shown signs of a
                                                                 continuously broad-based expansion. In particular,
                                                                 economic growth, which posted sustained
                                                                 expansion in Q2 2007, reflected robust personal
                                                                 consumption and the rise in government spending
                                                                 and investments. Increased economic output
                                                                 resulted in improved employment conditions.
                                                                 Furthermore, other demand indicators, such as land
                                                                 and rental values, vacancy rates, sales of
                                                                 commercial vehicles and appliances, energy
                                                                 consumption as well as the employment level,
                                                                 showed improvements in Q3. Meanwhile, the
                                                                 growth of merchandise exports slackened but
                                                                 imports rose.




    36
        In the Multi-Equation Model, the 90-day LIBOR impacts on the exchange rate via the interes t rate parity c ondition. A
    reduc tion in the LIBOR, c eteris paribus , leads to a widening of the differential between the domestic and foreign interest
    rates. The wider interes t rate differential induc es an appreciating trend on the exchange rate which, in turn, exerts
    downward pressure on inflation.




                                                                                                                            53
Supply Conditions

Agricultural production, which is subject to the
vagaries of weather conditions, could be a source
of food inflation pressures. Current ocean and
atmospheric conditions point to an early phase of a
weak La Niña phenomenon which could strengthen
and persist through the early months of 2008. This
may adversely affect agricultural production.
However, some indicators relevant to agricultural
production appeared to be normalizing.         The
significant rainfall experienced recently ended the
dry spell for most parts of the country, except for
isolated areas in northern Luzon and central
Visayas. Water levels in dams have normalized,
except for those in central Luzon which remained
critical.


Agricultural output growth is expected to continue,
supported by public spending on seed technology
and rural infrastructure. However, global prices of
some food items like rice, corn, wheat and dairy in
the international market are on the uptrend. The
surge in food prices was due in part to rising food
consumption in many emerging economies as well
as supply bottlenecks arising from unfavorable
weather conditions. Prospects of growth in
domestic production for rice and corn for the year,
although positive, are projected to be lower than a
year ago. The Government is currently undertaking
administrative measures to help temper inflationary
pressures arising from increases in the price of
these food items.

Movements in oil prices will also continue to
influence future inflation. International spot and
futures prices of oil have been rising on
expectations of increasing global demand and
supply concerns due to the hurricane and winter
seasons. However, the appreciation of the peso
should continue to exert a moderating impact on the
upward pressure exerted by rising oil prices and
global food prices on domestic inflation.




                                           54
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 the revised GDP data, preliminary
estimates yielded an output gap of 4.3 percent in
both Q1 and Q2 2007. It represents an increase
from the 2.9 percent reading in Q4 2006. The rise in
the output gap amid the record high expansion in
output in the first half of 2007 could indicate
possible demand pressures that may contribute to
inflationary pressures.



Inflation expectations

Expectations of future inflation from the results of
the BSP’s latest survey among the private sector
forecasters were lower for 2007 and 2008 in this
Inflation Report compared to the last report.
Moreover, results from the latest Consumer
Expectations Survey (CES) point to an increasing
number of consumers who expect inflation to slow
down in the next 12 months. At the same time,
based on the Business Expectations Survey (BES),
more business executives expect inflation to
decelerate in the third quarter but anticipate it to
move up in Q4 due to the usual increase in demand
during the holiday season.




                                            55
                                                             The latest baseline forecasts indicate that inflation
                                                             will continue to be benign over the policy horizon as
                                                             the risks to the inflation outlook have generally
                                                             moderated. In the absence of adverse shocks,
                                                             latest estimate of average inflation is expected to
                                                             remain well below the 4.0-5.0 percent target range
                                                             in 2007. For 2008, inflation could settle within the
                                                             4.0 percent ± 1.0 percentage point target. The
                                                             BSP’s forecasts were generated on the following
                                                             assumptions:

                                                                  a.   The National Government deficit remains
                                                                       unchanged at P63.0 billion in 2007 and a
                                                                       balanced budget in 2008.

                                                                  b.   The headline overnight RRP rate was
                                                                       assumed at 6.0 percent from October 2007
                                                                       to December 2008.

                                                                  c.   The 91-day T-bill rate was assumed at 3.9
                                                                       percent for the last three months of the year
                                                                       and 5.0 percent average in 2008.37

                                                                  d.   International crude oil prices are consistent
                                                                       with the latest BSP projections (as of 19
                                                                       September 2007, based on estimated
                                                                       futures prices) of US$65.83 per barrel for
                                                                       2007 and US$72.32 per barrel for 2008.

                                                                  e.   The nominal wage rate was assumed to
                                                                       increase by 6.9 percent in 2008.

                                                                  f.   The exchange rate             is    determined
                                                                       endogenously in the BSP’s Multi-Equation
                                                                       Model through purchasing power parity and
                                                                       interest rate parity relationships.




37
     For the BSP’s Multi-Equation Model, the 91-day T-bill rates are determined endogenously.




                                                                                                            56
Risks to the Inflation Outlook

Prices of international oil remains highly   The risks to the inflation outlook over the policy
volatile.                                    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 depicts a slightly lower and
                                             narrower inflation path relative to that of the
                                             previous quarter. The central projection is expected
                                             to accelerate beginning in the fourth quarter of 2007
                                             and climb steadily until the second quarter of 2008
                                             due to base year effects of low inflation during the
                                             first half of 2007. Thereafter, inflation is expected to
                                             sustain its levels toward the low-end of the 4.0
                                             percent ± 1.0 percentage point target due to the
                                             continued appreciation of the peso, well-anchored
                                             inflation expectations, and moderation of liquidity
                                             growth. While risks continue to surround the
                                             inflation outlook, they have, on balance, moderated
                                             as illustrated by the narrower bands above the
                                             central projection of the fan chart compared to the
                                             fan chart in the previous report. The growth of
                                             domestic liquidity decelerated for the fourth
                                             consecutive month in August, while weather
                                             conditions have normalized, supporting favorable
                                             supply of agricultural products. At the same time,
                                             the recent wage adjustments are not expected to
                                             generate significant inflationary pressures.



                                             Moreover, a firm peso is expected to temper price
                                             pressures coming from the rising global commodity
                                             prices, including food and oil. Moving forward, the
                                             main risks to the inflation outlook relate to the
                                             continued high volatility of oil prices, possible
                                             additional increases in wages, possible resurgence
                                             in liquidity due to sustained capital inflows, rise in
                                             global food prices, and dissipation of base year
                                             effects.




                                                                                            57
   Inflation Profile as of the Previous Quarter                 Latest Inflation Profile
                        Year-on-Year Inflation                                     Year-on-Year Inflation
     10                                                         10

      9                                                          9

      8                                                          8

      7                                                          7

      6                                                          6

      5                                                          5

      4                                                          4

      3                                                          3

      2                                                          2

      1                                                          1

      0                                                          0
          Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4            Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
             2005         2006              2007   2008                 2005         2006              2007   2008

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

Prices of      international oil remain highly              Continued Volatility of Oil Prices
volatile.
                                                            The high volatility of oil prices in the international
                                                            market remains a major source of possible
                                                            inflationary    pressure    in    the   near     term.
                                                            Developments in the US subprime market
                                                            weakened the price in the oil futures market but this
                                                            proved to be short-lived. Subsequently, the price of
                                                            oil in the international market rebounded to sustain
                                                            its uptrend despite the decision of OPEC to
                                                            increase its production. This was due to the tight
                                                            global oil supply, the onset of hurricane season—
                                                            which affected the outlook for the supply of oil—
                                                            falling inventories, and continued strong demand for
                                                            crude oil from China as well as in the US, following
                                                            the recent cut in the US federal funds rate.
                                                            Continuing high demand for oil and low surplus
                                                            capacity could spur expectations of higher oil prices
                                                            in the future. However, the potential impact of the
                                                            recent turmoil in the credit market on US growth
                                                            could be a mitigating factor which could dampen the
                                                            future demand for oil.




                                                                                                                58
Possible additional increases in wages, utility rates
and transport fare

The approved and pending petitions for increases in
wage and in the cost of living allowance (COLA)
may add to inflation pressure. However, the impact
is expected to be minimal since the approved wage
increases were generally lower than the amount
requested in the wage petitions.          Approved
increases in daily minimum wages in regions IV-A
and VI, and approved increase in the COLA in
region XII were implemented in October. Four
petitions for daily wage adjustments are pending
before the regional wage boards. There are also
petitions for legislated wage increases for both
private and public sector employees.


The pending petition by Meralco and the approved
adjustment in the settlement price in the spot
market may offset the recent electricity rate
reductions and could add to inflation pressures.
Possible sources of increase in electricity rates
could come from Meralco’s petition to recoup its
under-recoveries and adjustment in the spot
market’s settlement price.

The water tariff in Metro Manila is expected to
increase slightly in the fourth quarter due to the
adjustment in the foreign currency differential.
However, its inflationary impact is expected to be
minimal. The water rate hike to be implemented by
Manila Water Company and Maynilad Water
Services represented only about 0.1 percent growth
year-on-year, and water comprises only 0.85
percent of total CPI .


Tem pered growth of liquidity still needs to be
closely monitored

Liquidity growth has slowed down significantly but
remains important in the assessment of the outlook
for inflation. The slowdown in domestic liquidity
growth in the last few months reflected the impact
of the BSP’s new monetary measures to siphon off
excess liquidity.     Despite this development,
emerging trends in monetary aggregates still need
to be closely monitored in line with expectations of
sustained foreign exchange inflows.




                                            59
Uptrend in global non-oil commodity prices

International rice prices are trending upward due
mainly to higher demand from importing countries
and limited supply in exporting countries. Similarly,
global prices of some food products like dairy, corn,
and wheat have risen substantially. This was due
to the increasing use of some food items as source
of fuel (i.e. corn, soybean, and rapeseed oil) which
also affected the prices of non-fuel-related food
items, rising food consumption in emerging
markets, and the occurrence of unfavorable
weather conditions which affected food production
adversely. On the other hand, the appreciation of
the peso is expected to cushion, in part, the effects
on domestic prices of higher prices of non-oil
commodities in the international market.

Dissipation of base-year effects

The relatively high inflation rate experienced in
2006 yielded base-year effects which contributed to
the slowdown in inflation in 2007. However, the
relatively low inflation this year may contribute to
some upward base-year effects on inflation in 2008.




                                             60
Private Sector Economists’ Inflation Forecasts

Private sector forecasts continue to show                                                                                       Private analysts lowered their inflation forecasts
benign inflation outlook.                                                                                                       slightly for 2007 in Q3 on evidence of lower food
                                                                                                                                prices in the previous months. This quarter’s mean
                                                                                                                                inflation forecast for 2007 fell further to 2.8 percent
 Mean Inflation Forecasts by Private Sector Economists/Analysts
 In percent                                                                                                                     from 2.9 percent in the last quarter’s survey result.
     7.0                                                                                                                        Analysts noted that the firm peso arising from
     6.5                                                                                                                        steady OF remittances and foreign investments will
     6.0
                                                                                                                                continue to moderate prices. Furthermore, stable
     5.5
                                                                                                                                food supply will keep prices from rising. However,
     5.0


     4.5
                                                    2007
                                                                                                           2008
                                                                                                                                potential risks to inflation were cited such as strong
     4.0
                                                                                                                                growth in liquidity, increasing global oil prices and
     3.5                                                                                                                        possible additional adjustment in wages.
     3.0


     2.5


     2.0
            2005 Q 4     20 06 Q 1      2006 Q 2    2006 Q3      2006 Q4        2007 Q1        200 7 Q 2    2 007 Q 3           The mean inflation forecast for 2008 is also lower at
                                                                                                                                3.8 percent from the 3.9 percent projection in the
                                                                                                                                previous quarter.


Probability Distribution For Analysts' Inflation Forecasts*
2007 and 2008
                                                                                                                                Based on the probability distribution of respondents’
70
                                                                                                                                forecasts (from 12 out of 14 respondents), there is a
60
                                                                                                                                62.5 percent chance that inflation will be within 2.1-
50
                                                                                                                                3.0 percent, well below the 4.0-5.0 percent target
                                                                                                                                range in 2007. In 2008, there is a 51.9 percent
40
                                                                                                                                probability that inflation will settle around the lower
30
                                                                                                                                bound of the 4.0 percent ±1.0 percentage point
20
                                                                                                                                target for 2008.
10


 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      >10.0

                                             2007             2008
*Pro bability distribution was computed for probabilities provided by 12 respond ents
 (Source: BSP Survey)




                                                                                                                                                                              61
Private Sector Forecasts for GDP and Inflation
Annual Percent Change
                                              Inflation
                                         2007             2008
ATR Kim Eng Securities                    3.0              3.5
Bank of America                           2.5              3.2
Deutsche Bank                             2.8              3.5
Development Bank of Singapore             2.6              3.5
Forecast Pte Ltd (Singapore)              2.9              4.3
HSBC                                      2.7              4.2
IDEA                                      2.5              3.6
ING Bank                                  2.8              4.0
Metrobank                                 2.8               -
Nomura Securities                         2.9              3.6
Philippine Equity Partners                2.8              3.9
RCBC                                2.7-3.2 (3.0)     4.0-5.0 (4.5)
Standard Chartered Bank                   3.0              4.5
The Economist Intelligence Unit           2.8              3.4

Median Forecast                            2.8             3.6
Mean Forecast                              2.8             3.8
High                                       3.0             4.5
Low                                        2.5             3.2
Number of observations                     14              13

Memo Item:
Government Target                        4.0-5.0         4.0±1.0



VI. I MPLICATIONS FOR THE M ONETARY P OLICY S TANCE
The overall conditions for future inflation and                       Baseline forecasts indicate a more benign inflation
output show a benign inflation environment.                           outlook over the policy horizon. The lower actual
                                                                      inflation coupled with the significant deceleration of
                                                                      liquidity growth and a firmer peso accounted for the
                                                                      downward revision in the baseline forecast.
                                                                      Favorable food supply due to normalizing weather
                                                                      conditions and well-anchored inflation expectations
                                                                      also helped explain the subdued inflation
                                                                      environment amid the modest upward trend of
                                                                      demand-side indicators.

While risks continue to surround the inflation                        While risks continue to surround the inflation
outlook, they have moderated.                                         outlook, they have, on balance, moderated. The
                                                                      growth of domestic liquidity decelerated for the
                                                                      fourth consecutive month in August, while weather
                                                                      conditions have normalized, supporting favorable
                                                                      supply of agricultural products. At the same time,
                                                                      the recent wage adjustments are not expected to
                                                                      generate significant inflationary pressures. Moving
                                                                      forward, the main risks to the inflation outlook relate
                                                                      to the continued high volatility of oil prices, possible
                                                                      additional increases in wages, possible resurgence
                                                                      in liquidity given expectations of sustained strong
                                                                      capital inflows, rise in global food prices, and
                                                                      dissipation of base-year effects.




                                                                                                                     62
 Risks to the inflation outlook remain.    Despite the remaining risks, latest simulations show
                                           that the inflation path is expected to stay within the
                                           target over the policy horizon. The inflation outlook
                                           is expected to be resilient under various scenarios
                                           of foreign exchange inflows and domestic liquidity
                                           growth. A firm peso is expected to moderate the
                                           impact of higher world oil and global food prices on
                                           domestic inflation and the improvement in
                                           investments would help improve the capacity of the
                                           economy to absorb additional demand-side
                                           pressures and mitigate any potential overheating in
                                           the economy.

Monetary authorities will continue to be   The Monetary Board will continue to monitor global
watchful of any emerging risk to future    economic growth and the developments in the
inflation                                  global financial markets and remain watchful of any
                                           emerging risk to future inflation in its assessment of
                                           the monetary policy stance.




                                                                                        63
VII. CONCLUDING REMARKS

                          The inflation forecast is lower in this quarter
                          compared to the previous period. Risks to this
                          inflation outlook have significantly moderated. The
                          monetary measures in May have also helped
                          mitigate the impact of the continuing surge in
                          foreign exchange inflows on domestic liquidity
                          growth. Moreover, a relatively firm peso provides a
                          buffer against the potential price pressures from
                          higher prices of oil and food products in the
                          international market.

                          In view of the favorable inflation readings and the
                          moderation of risks, the Monetary Board decided on
                          4 October 2007 to reduce by 25 basis points the
                          BSP’s key policy interest rates to 5.75 percent for
                          the overnight borrowing or reverse repurchase
                          (RRP) rate and 7.75 percent for the overnight
                          lending or repurchase (RP) rate.

                          The problems from the US subprime mortgage
                          sector have yet to be resolved. The effects of the
                          financial correction went beyond the US housing
                          sector and disrupted global financial markets as
                          investors were forced to re-evaluate risks.

                          Although its effects were felt in the domestic equity
                          and foreign exchange markets at the onset of the
                          correction in August, the net impact of the US
                          subprime mortgage market meltdown on the
                          Philippine economy was minimal, given the strong
                          macroeconomic fundamentals, and relatively small
                          exposure of domestic banks to subprime mortgage-
                          backed securities.

                          Central banks around the world have implemented
                          coordinated efforts to avert a global financial crisis.
                          For its part, the BSP will remain attentive to the
                          increased risks that could arise from a potential
                          global economic slowdown and the possible
                          lingering effects of the global financial correction in
                          the domestic financial markets.




                                                                        64
                              Chronology of Monetary Policy Decisions


2000                                                 of the Monetary Board under the inflation-
                                                     targeting framework.
24 January 2000
                                                     14 February 2002
The Monetary Board–the policymaking body
of the BSP–adopted in principle the shift to         The Monetary Board opted to lower the BSP’s
inflation targeting as the BSP's framework for       policy rates further by 25 basis points each,
conducting monetary policy.                          bringing the overnight RRP rate to 7.25
                                                     percent and the overnight RP rate to 9.5
                                                     percent effective 15 February 2002.
2001
                                                     The Monetary Board also approved an
26 December 2001                                     adjustment in tiering scheme for banks’
                                                     overnight RRP placements with the BSP as
The BSP announced formally the adoption of           follows: 7.25 percent for placements of up to
inflation targeting as framework for monetary        P5 billion, 4.25 percent for the next P5 billion
policy beginning January 2002. The BSP also          and 1.25 percent for placements in excess of
announced the Government’s annual average            P10 billion. The tiering scheme also covered
inflation targets of 5.0-6.0 percent for 2002        special deposit accounts (SDAs) and would
and 4.5-5.5 percent for 2003.                        be applied on a consolidated basis.

                                                     14 M arch 2002
2002
                                                     The Monetary Board decided to reduce BSP’s
17 January 2002                                      key policy rates by another 25 basis points.
                                                     The overnight RRP rate was lowered to 7.0
The Monetary Board decided to reduce the             percent while the overnight RP rate was
overnight RRP and RP rates by 25 basis               reduced to 9.25 percent effective 15 March
points each to 7.5 percent and 9.75 percent,         2002.
respectively.
                                                     Correspondingly, the interest rates on
Consequently, the Monetary Board also                overnight RRP and SDA placements with the
adopted a change in the tiering structure for        BSP under the tiering scheme were adjusted
banks’ overnight RRP placements with the             as follows: 7.0 percent for placements of up to
BSP as follows: 7.5 percent for the first P5         P5 billion, 4.0 percent for the next P5 billion
billion, 4.5 percent for the next P5 billion and     and 1.0 percent for placements in excess of
1.5 percent for placements in excess of P10          P10 billion.
billion.
                                                     11 April, 8 M ay, 6 June, 4 July, 1 August,
The Monetary Board also approved a two-              29 August, 26 September, 23 October, 21
percentage-point reduction to 7.0 percent of         November, 19 December 2002
the liquidity reserve requirements on deposits
and deposit substitute liabilities, common trust     During the monetary policy meetings held for
funds and other trust and fiduciary liabilities of   the period April-December 2002, the Monetary
commercial banks and non-banks with quasi-           Board decided to keep the overnight RRP and
banking functions.                                   RP rates steady at 7.0 percent and 9.25
                                                     percent, respectively.
These monetary policy measures took effect
on 18 January 2002. Moreover, it could be
noted that this decision marks the first action




                                                                                                  65
2003                                               effective 5 June 2003. In particular, overnight
                                                   RRP placements would be subject to the
16 January 2003                                    following interest rates: 7.0 percent for the first
                                                   P5 billion, 4.0 percent for additional amounts
The Monetary Board voted to keep the BSP’s         in excess of P5 billion but below P10 billion
policy rates unchanged at 7.0 percent for the      and 1.0 percent for amounts in excess of P10
overnight RRP rate and 9.25 percent for the        billion.
overnight RP rate.
                                                   2 July 2003
7 February 2003
                                                   The Monetary Board voted to reduce the
The BSP announced the Government’s official        BSP’s key policy interest rates by 25 basis
target for the average annual inflation for 2004   points each to 6.75 percent for the overnight
at 4-5 percent.                                    RRP rate and 9.0 percent for the overnight RP
                                                   rate effective 2 July 2003.
12 February, 13 March 2003
                                                   The interest rates on banks’ placements under
The Monetary Board kept the BSP’s policy           the tiered system were also adjusted as
rates unchanged at 7.0 percent for the             follows: 6.75 percent for the first P5 billion,
overnight RRP rate and 9.25 percent for the        3.75 percent for amounts in excess of P5
overnight RP rate.                                 billion up to P10 billion and 0.75 percent in
                                                   excess of P10 billion.
19 March 2003
(Special Monetary Board Meeting)                   31 July 2003

The Monetary Board decided to lift the three-      The Monetary Board left the overnight RRP
tiered scheme on banks’ placements with the        and RP rates unchanged at 6.75 percent and
BSP. Thus, overnight placements under the          9.0 percent, respectively.
RRP window would be accepted at a flat rate
of 7.0 percent effective 20 March 2003.            28 August 2003

The Monetary Board also raised the liquidity       The Monetary Board opted to keep the BSP’s
reserve requirement against peso demand,           policy rates unchanged at 6.75 percent for the
savings, time deposit and deposit liabilities of   overnight RRP rate and 9.0 percent for the
universal banks and commercial banks by            overnight RP rate.
one-percentage point to 8.0 percent effective
21 March 2003.                                     The Monetary Board also decided to lift the
                                                   tiering scheme for banks’ placements with the
10 April, 8 M ay 2003                              BSP. Thus, effective 28 August 2003,
                                                   overnight RRP transactions with the BSP
The Monetary Board maintained the overnight        were accepted at a flat rate of 6.75 percent.
RRP and RP rates steady at 7.0 percent and
9.25 percent, respectively.                        2 October, 23 October, 20 November, 18
                                                   December 2003
5 June 2003
                                                   The Monetary Board voted unanimously to
The Monetary Board decided to leave the            leave the BSP’s policy rates unchanged at
overnight RRP and RP rates unchanged at            6.75 percent for the overnight RRP rate and
7.0 percent and 9.25 percent, respectively.        9.0 percent for the overnight RP rate.

The Monetary Board also decided to restore
the tiering scheme on banks’ placements with
the BSP under the RRP and SDA windows




                                                                                                  66
2004
                                                 7 July 2005
15 January 2004                                  (Special Monetary Board meeting)

The Monetary Board decided to keep               The Monetary Board raised the regular and
monetary policy settings unchanged. The          liquidity reserve requirement ratios by 100
overnight RRP and RP rate were maintained        basis points each to 10 percent and 11
at 6.75 percent and 9.0 percent, respectively.   percent, respectively, effective 15 July 2005.

5 February 2004                                  28 July, 25 August 2005
(Special Monetary Board Meeting)
                                                 The Monetary Board left key policy rates
The Monetary Board decided to increase the       unchanged at 7.0 percent and 9.25 percent for
liquidity reserve requirement for universal      the overnight RRP rate and overnight RP rate,
banks and commercial banks by two                respectively.
percentage points to 10 percent effective 6
February 2004.                                   22 September 2005

12 February, 11 March, 15 April, 6 May, 3        The Monetary Board decided to raise the
June, 1 July, 29 July, 26 August, 23             overnight RRP rate and RP rate by 25 basis
September, 21 October, 18 November, 16           points to 7.25 percent and 9.5 percent,
December 2004                                    respectively.

The Monetary Board opted to maintain the key     20 October 2005
rates steady at 6.75 percent and 9.0 percent
for the overnight RRP rate and overnight RP      The Monetary Board raised the key policy
rate, respectively.                              rates by 25 basis points to 7.5 percent and
                                                 9.75 percent for the overnight RRP and RP
                                                 rates, respectively.
2005

13 January, 10 February, 10 March 2005           17 November, 15 December 2005

The Monetary Board decided to maintain the       The key policy rates were left unchanged at
BSP’s key overnight RRP and RP rates             7.5 percent and 9.75 percent for the overnight
unchanged at 6.75 percent and 9.0 percent,       RRP and RP rates, respectively.
respectively.

7 April 2005                                     2006

The Monetary Board voted unanimously to          12 January, 9 February, 9 March, 6 April,
raise the overnight RRP and RP rates by 25       4 May, 1 June, 29 June, 10 August, 21
basis points each to 7.0 percent and 9.25        September 2006
percent, respectively.
                                                 The Monetary Board decided to maintain the
5 May, 2 June, 30 June 2005                      policy rates at 7.5 percent and 9.75 percent
                                                 for the overnight RRP and RP rates,
The Monetary Board decided to keep the           respectively.
BSP’s policy interest rates at 7.0 percent for
the overnight RRP rate and 9.25 percent for
the overnight RP rate.




                                                                                            67
2 November                                       c) Allow SDA placements of banks to be
                                                 deemed as alternative compliance with the
The Monetary Board decided to keep policy        liquidity floor requirements for government
rates unchanged at 7.5 percent and 9.75          deposits.
percent for the overnight RRP and RP rates,
respectively.                                    These measures will take effect on 10 May
                                                 2007.
At the same time, the Monetary Board
adopted a tiering system on banks’ aggregate     28 May
placements with the BSP under the RRP and
SDA windows effective 2 November 2006. In        The key policy rates were left unchanged at
particular, placements under the said windows    7.5 percent and 9.75 percent for the overnight
would be subject to the following interest       RRP and RP rates, respectively. The tiering
rates: the applicable BSP published rate for     system for bank placements under the RRP
the first P5 billion, the applicable BSP         and SDA windows was also maintained.
published rate less 200 basis points for the
next P5 billion; and the applicable BSP
published rate less 400 basis points for         12 July
amounts in excess of P10 billion.
                                                 The tiering system for bank placements under
14 December                                      the RRP and SDA windows was lifted and the
                                                 key policy rates were reduced to 6.0 percent
The key policy rates were left unchanged at      and 8.0 percent for the overnight RRP and RP
7.5 percent and 9.75 percent for the overnight   rates, respectively.
RRP and RP rates, respectively. The tiering
system for bank placements under the RRP
and SDA windows was also maintained.             23 August

                                                 The key policy rates were left unchanged at
2007                                             6.0 percent and 8.0 percent for the overnight
                                                 RRP and RP rates, respectively.
25 January, 8 March

The key policy rates were left unchanged at
7.5 percent and 9.75 percent for the overnight
RRP and RP rates, respectively. The tiering
system for bank placements under the RRP
and SDA windows was also maintained.

16 April

The key policy rates were left unchanged at
7.5 percent and 9.75 percent for the overnight
RRP and RP rates, respectively. The tiering
system for bank placements under the RRP
and SDA windows was also maintained.

The Monetary Board also approved new
monetary measures as follows:
a) Encourage GSIS, SSS, and other GOCCS
to deposit funds with the BSP;
b) Allow trust departments of banks to
deposit with the BSP; and




                                                                                            68
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

				
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