PAMANTASAN NG LUNGSOD NG MAYNILA

PLM Business School

PUBLIC FINANCE
Module 1:
Public Fiscal Management
Chapter 1:
Overview of Public Fiscal Administration
Prepared by:
Prof. Ragrciel Grafil Manalo
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 TOPICS OUTLINE

I. Overview of Public Fiscal Administration

A. Public Finance and Public Fiscal Administration

B. Politics and Fiscal Administration
C. Analytical Framework
D. Fiscal Policy and Monetary Policy
1. Fiscal Policy, Functions
2. Monetary Policy, Tools
E. Components of the Public Sector
1. Government Fiscal Agencies
2. Bangko Sentral ng Pilipinas
F. Public Fiscal Administration in Developing Countries

Prof. Ragrciel Grafil Manalo

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 LEARNING OBJECTIVES

1. Understand the overall administration of public financial

system;
2. Develop deeper insights and better understanding of
public fiscal administration in Philippine setting;
3. Identify and analyze the existing problems involved in
public finance;
4. Gain complete understanding of the public finance cycle.
5. Differentiate the concepts embodied in public fiscal
administration and examine the analytical framework of
the course.
6. Analyze the coordination and conflict of fiscal policy when
pursuing multiple economic objectives.

Prof. Ragrciel Grafil Manalo

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 Introduction

THESE GOVERNMENT ACTIVITIES WOULD ENTAIL EXPENSES

THUS, THE NEED TO GENERATE REVENUE OR FUNDING, AND

EFFICIENTLY AND EFFECITIVELY ALLOCATE THESE FUNDS

ACCORDING TO PRIORITIES OF COMPETING NEEDS

Prof. Ragrciel Grafil Manalo

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PUBLIC FISCAL ADMINISTRATION AND PUBLIC FINANCE
PUBLIC FINANCE PUBLIC FISCAL ADMINISTRATION
= closely related
= both talk about revenue and expenditures
 a subject area or branch in  also talks about government
economics which deals with the revenues and expenditures and their
revenues and expenditures patterns of impact in the economy
the government and their various
effects on the economy
 has always been considered part of  concerned with the implementation
economics and practicalities of these concepts
 Economics – Deals with the
utilization of scarce resources that
have alternative uses to satisfy human
wants.
 deals with certain financial issues  Encompasses the practical aspects
at a rather broad of fiscal governance such as:
conceptual level > revenue collection
> preparation of budgets
e.g. real problems as economic > budget allocation and spending
incentives , aggregate employment, > management of debt
and inflation > auditing of account 10
PUBLIC FISCAL ADMINISTRATION AND PUBLIC FINANCE
PUBLIC FINANCE PUBLIC FISCAL ADMINISTRATION
Deals with, but is not restricted to the more
limited issues covered by public fiscal

In recent times, however, with the

emergence of the field of public
administration, much interest has been
directed towards the political administrative
and management aspects of formulating,
implementing and evaluating fiscal policy-
hence, the term public fiscal administration

Is centered on the determination and

analysis of fiscal policies starting from their
formulation to their implementation and
evaluation.

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Prof. Ragrciel Grafil Manalo
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PUBLIC FINANCE AND PRIVATE FINANCE
PUBLIC FINANCE PRIVATE FINANCE
 , governments can generate resources  cannot avail of taxation, printing of
through taxation, printing money, money as means of raising revenue.
borrowing, or through the sale of
assets and services
• on
 can rely more heavily . borrowing to  however, it can float securities (bonds
augment its resources than can private and commercial papers) or issue shares of
firms. stocks or utilize its income and other
assets.
 determines first its expenditure needs,  the preparation of the budget starts from
and then look around for possible ways of the income side, that is, entity determines
financing them. income and additional resources from
 this budgeting procedure can indeed borrowings, and then proceeds to individual
contribute to deficit spending. expenditure items
 deficit spending occurs when
government receipts (including
borrowing) do not fully cover
government expenditures.
 deficit financing may, at times be an  this situation represents faulty
acceptable alternative. management 12
PUBLIC WANTS AND PRIVATE WANTS
PUBLIC WANTS
Public wants are those that cannot be
satisfied through the working of the
market because their enjoyment by any
individual consumer is independent of
his payment or contribution.
One is not excluded from the
satisfaction of a public want even if he
does not pay for it.
ALTHOUGH the market mechanism can
adequately provide for private wants,
public wants must be satisfied through
the budget, if they are to be satisfied at
all
Public wants can be classified into:
1. Social wants
2. Merit wants
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Prof. Ragrciel Grafil Manalo
PRIVATE WANTS
Private wants are those that can be
satisfied through the mechanism of
market because their enjoyment can
be made subject to price payments.
Exclusion Principle holds that a
person is excluded from the
satisfaction or enjoyment of a
particular commodity or service if he is
not willing to pay the designated price
to the seller
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SOCIAL WANTS AND MERIT WANTS
SOCIAL WANTS MERIT WANTS
SOCIAL WANTS are wants whose satisfaction MERIT WANTS are those that are subject to
should be subject to the principle of the exclusion principle and are satisfied by
consumer sovereignty, that is, resources the market within the limits of effective
should be allocated in response to the demand.
effective demand of consumer
They become MERIT WANTS if considered
Social wants are quite similar in this so meritorious that their satisfaction is
fundamental respect to the private wants provided for through the government budget,
over and above what is provided for through
the market and paid for by private buyers.
Ex. Free education, low cost housing
The difference between SOCIAL & MERIT WANTS
While both types of public wants are provided for through the government budget, they create
different problems:
Social wants bring with them the problem that the same amount has to be consumed by all.
The satisfaction of merit wants, on the other hand, by their nature, involves the problem of
interference with individual consumer preferences.
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Prof. Ragrciel Grafil Manalo 14
 OVERVIEW OF PUBLIC FISCAL ADMINISTRATION

PUBLIC FINANCE has always been considered part

of economics. In recent times, however, with the
emergence of the field of public administrations,
much interest has been directed toward the
political administrative and management aspects
of formulating, implementing and evaluating
fiscal policy – hence, the term PUBLIC FISCAL
ADMINISTRATION

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Prof. Ragrciel Grafil Manalo
OVERVIEW OF PUBLIC FISCAL ADMINISTRATION
PUBLIC FISCAL ADMINISTRATION
refers to the
 TAXATION
 Formulation  REVENUE ADMINISTRATION
 Implementation  RESOURCE ALLOCATION
 Evaluation  BUDGETING
 PUBLIC EXPENDITURE
 BORROWING
 DEBT MANAGEMENT
of the Policies  ACCOUNTING
and  AUDITING
Decisions on

As a system, it includes the environment structures, systems, processes

and personalities evaluating fiscal policies
FISCAL POLICY refers to the mix of policies on taxation, expenditures
and_______________________________
borrowings for the achievement of government objectives.
Prof. Ragrciel Grafil Manalo
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PUBLIC FISCAL ADMINISTRATION
NGAs
Government GOCCs
PUBLIC Sector GFIs
= MEAN THE WHOLE LGUs

people whom the beneficiaries, voters,

government serve taxpayers, youth,
farmers, urban poor
= ALSO MEAN THE

Closely linked with other policy instruments

of the government such as MONETARY,
FISCAL = refers to FISCAL
PRICE and TRADE POLICY, INVESTMENT
POLICIES
and WAGE.

Formulation
ADMINISTRATION Implementation
Government’s
FISCAL
= refers to the Evaluation POLICIES
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Prof. Ragrciel Grafil Manalo
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POLITICS AND FISCAL ADMINISTRATION
 Administration of FISCAL POLICIES actually takes place
within a Political System
 Public Fiscal Administration and Political Process are
interrelated and influence each oher

ADMINISTRATION
referring to carrying out or implementing that
collective will of the society
POLITICS
referring to formulating of laws and policies as
expression of the collective will of the state

Legislature

Rule Making
Formulate and recommend urgent
policy measures for congressional
deliberation and approval Also engaged in POLICY
implementation thru their PORK
BARREL funds
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Prof. Ragrciel Grafil Manalo 18
 COMPONENTS OF THE PUBLIC SECTOR
General Appropriation Act
= called the national government budget
NGAs = contain subsidies, transfers, and/or allotments
to GOCCs, GFIs, and LGUs

GOCCs
Have their own distinct
GFIs and separate budgets
LGUs

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Prof. Ragrciel Grafil Manalo
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 OTHER AGENCIES CONCERNED IN THE
FORMULATION, IMPLEMENTATION,
AND EVALUATION OF FISCAL POLICY
Bureau of
Internal
Revenue  Implementation of
(1) policies on TAXATION
and TARIFF
Department Bureau
of of Custom
Finance

Bureau of Custodian of
Treasury Government Funds

(2) leads the formulation of

Department of expenditure policy as well as
Budget and borrowing
Management
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Prof. Ragrciel Grafil Manalo
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 central planning body
(3)
National
Economic formulate, review, and assess fiscal policy
Development
Authority
prepares / prescribes the programs, projects and activities of
government and how these prioritized and finance

(4)
Bangko major actor in the fiscal policy process to ensure that monetary
Sentral Ng policies are in consonance with fiscal policy decisions
Pilipinas

International Lending
Institutions
(5)
External both influence
Forces the fiscal policy
Government giving agencies
administration
( e.g. IMF, WB, ADB )
give advise on fiscal and other
policies of the government
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Prof. Ragrciel Grafil Manalo 21
  formulates the policy framework for the National
Budget
(6)  determines the level of deficit establishes the priorities
DEVELOPMENT and the amount of allocation for the sectors
BUDGET AND
COORDINATION Department of Budget
COUNCIL and Management Secretary – (Chairman)

National Economic Development Authority

(Director – General)

Composition
Department of Finance Secretary - Member

Bangko Sentral Ng Pillipinas

Governor - Member

Office of the President –Representative –

_______________________________ Member
Prof. Ragrciel Grafil Manalo
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The Major Functions of
DEVELOPMENT BUDGET AND COORDINATION COUNCIL (DBCC)
1. Establishment of the level of annual government expenditure
program and ceilings of government spending in economic and
social development, national defense, general government and
debt services;

2. Determination of the proper allocation of expenditures for each

development activity between current operating expenditures (COE)
and capital outlays (CO), allotting not more than 85% of total
government expenditures to COE and at least 15% to capital outlays.

3. Allocation of the amount set for capital outlays under each

development activity for the various capital infrastructure projects;

4. Assessment of the reliability pf revenue estimates;

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Prof. Ragrciel Grafil Manalo
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The Major Functions of
DEVELOPMENT BUDGET AND COORDINATION COUNCIL (DBCC)
5. Recommendation of appropriate tax or other revenue measures
and extent and type of borrowings;

6. Conduct of periodic review and general examination of costs,

accomplishment, and performance standards applied in undertaking
development projects, including the review of a mid year and annual
budgetary performance;

7. Approval and recommendation to the President of general policy

guidelines in the preparation of the national budget; and

8. Approval and confirmation of various requests of the Ministry of

Finance for bond floatation.

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Prof. Ragrciel Grafil Manalo
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 FISCAL POLICY AND MONETARY POLICY
FISCAL POLICY MONETARY POLICY
 refers to the combination of policies on:  concerned with the control of the
TAXATION aggregate supply of money (cash in
EXPENDITURES adopted by the pockets and balances in bank accounts)
BORROWING government in the economy and is monitored and
BUDGETING to achieve shaped primarily by the Central Bank
ACCOUNTING objectives
AUDITING  tight and easy money regimes are simply
its effects
 End product of fiscal administration  its major objectives are price
stabilization, full employment, and
economic growth
 Serves as tools to achieve general  its conduct is an art, involving a delicate
welfare objectives, and shape and influence balancing act, the use of appropriate tools,
by the POLITICAL PROCESS the sending of proper signals to the market
on its broad intentions
Note: Have no dividing line as to the impact of fiscal and monetary policies in
the economy
Example: a decision to incur a budget deficit ( a matter of fiscal policy) will
require domestic borrowing thru the issuance of treasury bills which
affect the money supply (monetary policy).
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Prof. Ragrciel Grafil Manalo 25
FISCAL POLICY FUNCTIONS
1. ALLOCATION
 It is the process by which total resource use is divided between private and social
goods and which the mix of social goods is chosen.

 In the performance of allocation function, fiscal policy is expected to regulate the

balance in making available both private goods, merit goods, and social goods. The
government intervenes through subsidies, price regulation, and direct provision of
social goods.
2. DISTRIBUTION
 The distribution of income and wealth is shaped by the distribution of the factors of
production.
 Fiscal policy is directed toward correcting this income and wealth.
ex. high tax for rich, and low tax for poor; favorable public policies on agrarian reform,
wages, labor and employment, among others 26
FISCAL POLICY FUNCTIONS
3. STABILIZATION
 instability may be due to changes in prices of major imports, cost of foreign
borrowings, and the availability of foreign borrowings which lead to huge deficits in
the budget and balance of payments and trade.
 Using expenditure and tax policies for stabilization in developing countries may be
more difficult. An increase in expenditures may entail either additional taxes or more
borrowing. The low tax base and inefficient tax administration makes a case of public
borrowing.
 A country aspiring to achieve growth and development may have to experience
instabilities and suffer chronic balance of payments deficit, severe inflation, high levels
of unemployment and underemployment and the like.
4. Development (in developing countries)
 Development is an expensive endeavor. For it to be achieved by developing countries,
a radical shift in revenue and expenditure priorities is called for.
 Human development – process of enlarging the range of people’s choices; increasing
their opportunities for education, health care, income and employment, and covering
the full range of human choices from a sound physical environment and political
freedom.
 Sustainable development – is a process of change in which the exploitation of
resources, the direction of investments, the orientation of technological development,
and institutional change are made consistent with future as well as present needs.
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Prof. Ragrciel Grafil Manalo 27
28
GRAPHICAL ANALYTICAL FRAMEWORK
TOOL TO THE STUDY OF THE ROLE OF FISCAL POLICY AND ITS CONTRIBUTIONS TO THE SHAPING, IMPLEMENTATION, AND REALIZATION OF
THE COUNTRY’S VISIONS AND GOALS OF DEVELOPMENT

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 BANGKO SENTRAL NG PILIPINAS (BSP)

Republic Act 7653 • To cover up the realized P200B losses

incurred by the Old Central Bank
June 1993
• To conduct monetary policy more
NEW CENTRAL BANK independently

Republic Act 265 •To exit from the inflexible Gold

June 1948
OLD CENTRAL BANK
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Prof. Ragrciel Grafil Manalo
Standard or 100% Currency
Reserve System that was in
place before the World War II
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BANGKO SENTRAL NG PILIPINAS (BSP)
MANDATES
Maintain PRICE STABILITY conducive to a balanced sustainable
growth of the economy (the adoption of INLATION TARGETING of
Monetary Policy is aimed at achieving this objective

Promote and maintain MONETARY STABILITY and

convertibility of the peso

To control any expansion or contraction in the Monetary

Aggregates which is prejudicial to the attainment or
maintenance of price stability

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Prof. Ragrciel Grafil Manalo 31
 TARGETS OF MONETARY POLICY
- GIVEN THE EFFECT OF MP ON THE INFLATION RATE, INTEREST RATES AND LEVELS
OF OUTPUT AND EMPLOYMENT, AND GROWTH, MONETARY AUTHORITIES TRY TO
TARGET SOME VARIABLES IN ORDER TO ACHIEVE A CERTAIN INFLATION RATE OR GNP
GROWTH

1
MONETARY
AGGREGATES
• Refers to the different
measures of money. As per
the Quantity Theory of
Money, money supply
increases do tend to raise
the inflation rate
2 3
INTEREST RATES
• It does not directly target.
Rather, BSP uses the
policy interest rates for
Repurchase Agreements
(Repos) and Reverse
Repos (RRP) to signal to
the market their intention
to tighten or loosen
monetary policy or simply
maintain the status quo.
• These are made by the
Monetary Board.
INFLATION RATES
• The government inflation
target is defined in terms
of the average year-on-year
change in the consumer
price index (CPI) over the
calendar year.
• Focused mainly on
achieving a low and stable
inflation.

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Prof. Ragrciel Grafil Manalo 32
TOOLS OF MONETARY POLICY
(monetary policy instruments used by the BSP to ease and tighten credit in the economy
thus promote price stability, and increase or reduce liquidity in the financial system)

A. Tools Aimed at Monetary Aggregates

1. Purchase / Sale of Foreign Exchange in the FOREX Market
 in order to ensure that banks are able to provide ample liquidity in the
market but, at the same time, conduct their business in a sound manner, and
guard against speculative activity, limits on their “net open foreign exchange
position” are instituted.
 “Open Foreign Exchange Position” shall refer to the extent that banks'
foreign exchange assets do not match their foreign exchange liabilities
 An open position may either be:
o "positive", "long", or "overbought"
(i.e., foreign exchange assets exceed foreign exchange liabilities) or
o "negative", "short", or "oversold"
(i.e., foreign exchange liabilities exceed foreign exchange assets).

 Allowable Open Foreign Exchange Position. Banks' allowable open foreign

exchange position (either overbought or oversold) shall be the lower of 20
percent (20%) of their unimpaired capital or USD50 million.
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Prof. Ragrciel Grafil Manalo 33
 Any excess of the allowable limit shall be settled on a daily basis.

Penalties on excess overbought and oversold positions of banks when

PDS trading is suspended shall be waived.

2. Open Market Operations - are a key component of monetary

policy implementation. These consist of repurchase and reverse repurchase
transactions, outright transactions, and foreign exchange swaps.

Repurchase and Reverse Repurchase

a. In a repurchase or repo transaction, the BSP buys government
securities from a bank with a commitment to sell it back at a specified
future date at a predetermined rate.
- The BSP’s payment to the bank increases the latter’s reserve
balances and has an expansionary effect on liquidity.
b. In a reverse repo, the BSP acts as the seller of government securities
and the bank’s payment has a contractionary effect on liquidity

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Prof. Ragrciel Grafil Manalo 34
  Repurchase Agreements (REPOs)

 Isa contract by which one sells securities to another party

with the agreement to buy it back at some future time and
at a higher price.

 Itjust lending money with a security or collateral.

 The price has to be higher price to represent the interest
on the money lent.

 The underlying security may be a government or private

debt instrument, like t-bills or corporate note. (see next slide
for the given example)

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Prof. Ragrciel Grafil Manalo 35
Example of REPO
Let’s say BPI has a promissory note of P100M of Ayala Corp. If it needs short term funds,
it can go to the money market and borrow money on the basis of a REPO. Thus, it will
sell the Ayala Corp. note for a certain amount lower than the face value, together with
a commitment to buy back that note at face value. The difference (plus the interest
that will be earned by the holder of the promissory note) will be at current market
rates. So BPI is able to raise close to P100M through the REPO. At the end of the term
(say 90 days), it will buy back the debt instrument for P100M.

SELL SELL
AYALA Corp.
Current Market Rate = 15% BPI MONEY MARKET
Borrowed Money= P85M out or BSP
of P100M worth of ITS
ISSUED short term debt Current Market Rate = 12%
instrument (low risk and liquid Lent Money = P88M Lent Money – P88M
@ 182 days)

BUY BACK BUY BACK

BPI
Ex. 91 days as agreed
MONEY MARKET
@ the amount of P100 M
AYALA Corp. or BSP
Received Payment = P100 M
Payout = P100 M (upon Lent Money = P85 M Received Payment = 100M
maturity of 182 days) Borrowed Money = P88 M Lent Money – P88M
Earnings = P3M Earnings = P12M
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Prof. Ragrciel Grafil Manalo 36
  Reverse Repurchase Agreements (RRP)

 is the same agreement when viewed from the side of the

lender funds who may be initiating the transaction

 ordinarily, these are carried out between private financial

institutions (especially banks and quasi banks) in the money
market.

 are commonly done by the BSP for the purpose of

removing liquidity from the money market.

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Prof. Ragrciel Grafil Manalo 37
 REVERSE REPURCHASE AGREEMENT
SELL SELL SELL
AYALA Corp. BPI Money Market KBs
(original borrower) or BSP Extend credit of
Issue same security amounting
Issue same security amounting P89M
Issue security to P100M
to P100M
amounting to P100M @ CMR = 12%
@CMR = 11%
= payable after 182 days Accepted money = P88M
Accepted money = P89M
(@ CMR =15%) With a promise to buy it back
With a promise to buy it back
Accepted money= P85M after 91 days
after 91 days

REVERSE REPURCHASE AGREEMENT

BUY BACK BUY BACK
AYALA Corp. BPI Money Market KBs
(original borrower) or BSP (original lender)
 Received payment
 pay the borrowed P100M  Received payment  Received payment
amount of P100M Lent money=P85M of P100M of P100M
Borrowed money =P88M Lent money=P88M  Earnings = P11M
 Earnings = P3M Borrowed money =P89M
 Earnings = P1M

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Prof. Ragrciel Grafil Manalo 38
 Note:
 credit transaction is at a discount loan type
(especially for T-bills which is a zero-coupon bond)

 current market rate is based on the prevailing

interest rate as per the yield curve which is the
usual basis of the private corporations in the
imposition of their lending rates.

 the most common financial institution which

issues reverse repo is the BSP.
 Philippines Yield Curve – 27 March 2021. Philippine Government Bonds

http://www.worldgovernmentbonds.com/country/philippines/

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Prof. Ragrciel Grafil Manalo 39
 3. Outright transactions
 refer to the direct purchase/sale by the BSP of its holdings of
government securities from/to banking institutions.
 In an outright transaction, the parties do not commit to reverse
the transaction in the future, creating a more permanent effect on
money supply.
 The transactions are conducted using the BSP’s holdings of
government securities.
 When the BSP buys securities, it pays for them by directly crediting
its counterparty’s Demand Deposit Account with the BSP.
 The transaction thus increases the buyer’s holdings of central
bank reserves and expands the money supply.
 Conversely, when the BSP sells securities, the buyer’s payment
(made by direct debit against his Demand Deposit Account with the
BSP) causes the money supply to contract.

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Prof. Ragrciel Grafil Manalo 40
 4. FOREIGN EXCHANGE SWAP
refer to transactions involving the actual exchange of two currencies
(principal amount only) on a specific date at a rate agreed on the deal
date (the first leg), and a reverse exchange of the same two currencies at
a date further in the future (the second leg) at a rate (different from the
rate applied to the first leg) agreed on deal date.

The Situation
You currently have EUR 500,000 in currency available to your firm,
sitting in a bank account in Europe, invested at short-term rates.
You have a funding requirement of USD 450,000 for three months in
the United States and wish to utilize your EUR funds to meet this
funding requirement.
You do not wish to take any foreign exchange risk on this transaction.
What is Foreign Exchange Risk?
It refers to the losses that an international financial transaction may incur due to
currency fluctuations. Also known as currency risk, FX risk and exchange-rate risk, it
describes the possibility that an investment’s value may decrease due to
changes in the relative value of the involved currencies. Investors may
experience jurisdiction risk in the form of foreign exchange risk.
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 FOREIGN EXCHANGE SWAP

 The Product (Foreign Exchange Swap)

 Allows you to utilize the funds you have in one currency to fund
obligations denominated in a different currency, without incurring
foreign exchange risk.

 It is an effective and efficient cash management tool for companies

that have assets and liabilities denominated in different currencies.

 On the near date, you swap one currency for another at an agreed
foreign exchange rate and agree to swap the currencies back again
on a future (far) date at a price agreed upon at the inception of the
swap.

 In most cases, currencies are initially swapped at the spot rate and
the future (far) rate is calculated by adjusting the spot price by the
forward points for the length of time the swap transaction runs for.
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Prof. Ragrciel Grafil Manalo 42
 The Solution
 In the situation outlined above, you would agree to sell the EUR to the bank at
the spot rate of 0.90.
 A full exchange of funds takes place on the near date and you would deliver
EUR 500,000 to the bank. In return the bank will deliver USD 450,000 to you on
the near date (typically but not always the spot date).
 At the same time, you would agree to buy back the EUR and send back the USD
in three months time at a spot price of 0.90, adjusted for forward points of -
.0045, for a forward price of 0.8955.
 In this case, on the future (far) date the bank would return the EUR 500,000
and you would send the bank USD 447,750
 The forward points adjustment is easily explained and calculated. In this case,
assume the prevailing interest rate in Europe are 5% and in the United States
are 3%.
 By entering into the foreign exchange swap with the bank you are giving them
the use of a currency which they could invest at 5% and in return they are
giving you the use of USD which you could only invest at 3%.
 The purpose of the forward points adjustment is to equalize this interest rate
differential and compensate you for 'giving up' or 'receiving' the higher
interest-bearing currency,
 The forward points are easy to calculate and in a simple method.
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Prof. Ragrciel Grafil Manalo 43
 SPOT DATE NEAR DATE FORWARD DATE
Agree to sell the Full exchange of funds
EUR @ Spot Rate of 0.90 (EUR500T and USD450T)
and BUY IT BACK after On the near date, you swap one currency for another at an
agreed foreign exchange rate and agree to swap the
3 months for a forward currencies back again on a future (far) date at a price agreed
upon at the inception of the swap.
price of 0.8955

ON FUTURE DATE (after 3 months)

send the bank USD447,750

Bank would return the EUR500T

In this case, assume the prevailing Interest rates in Europe are 5% and in US are 3%
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Prof. Ragrciel Grafil Manalo 44
Spot Exchange Rate = 0.9000
Bank receives EUR500T and pays you USD450T
USD450T = 0.9000
EUR500T

Forward Exchange Rate = 0.8955

USD450T X 3% X 90/360 = USD3,375 + USD450T = USD453,375
EUR500T X 5% X 90/360 = EUR6,250 + EUR500T = EUR506,250
USD453,375 = 0.8955
EUR506,250

At far date
BANK returns the EUR500T @ agreed upon rate of 0.8955 and you send the bank
USD447,750 = (EUR500T X 0.8955)

Amount of your EARNINGS on EUR500T for three months translated back to USD = $2,250
(USD450T X 2% X 90/360 = USD2,250

INTEREST RATE IN EUROPE (5%) LESS INTEREST RATE IN US (3%) = 2%

NOTE:
In cases where your surplus funds are in a currency with a low interest rate and your funding
need is in a country with a higher interest rate environment, the forward points will be “against you”
and the “gain” in the example above would be reversed.
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Prof. Ragrciel Grafil Manalo 45
5. Non-Global Tools
a. Selective Controls
- BSP may require a higher percentage as marginal deposit for
consumption imports, thereby discouraging the importation of luxury
consumption items.

- Also, the BSP may classify commercial bank loans into priorities where
it states that loans for consumption purposes are not eligible for rediscounting
while loans for investment are.

- In other words, the BSP has the power to make credit difficult to purchase
some items and easy to purchase others.

b. Moral Suasion
- BSP can hold sessions with commercial banks in an effort to gear them
toward national goals in carrying out their banking activities.

- With moral suasion power to limit rediscounting, opening of branches

and impose other administrative requirements, the BSP can talk the banks to
the the line of monetary policy.
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Prof. Ragrciel Grafil Manalo 46
TOOLS OF MONETARY POLICY

B. Tools Aimed at Influencing the Multiplier or Interest Rate

1. Reserve Requirements - refer to the percentage of bank deposits and
deposit substitute liabilities that banks must keep on hand or in deposits with
the BSP and therefore may not lend.
Money multiplier is inversely related to the required reserves percentage.
If the required reserves are low, banks can lend more of their deposit and the
multiplier is high. If it is increased, banks can lend less and the multiplier
goes down.
Changes in reserve requirements have a significant effect on money
supply in the banking system, making them a powerful means of liquidity
management.
 Reserve requirements apply to peso demand, savings, time deposit and
deposit substitutes (including long-term non-negotiable tax-exempt certificates of
time deposit or LTNCTDs) of universal banks (UBs) and commercial banks (KBs)
and may be kept in the form of cash in vault, deposits with the BSP and
government securities.
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Prof. Ragrciel Grafil Manalo 47
 TOOLS OF MONETARY POLICY

 Required reserves consist of two forms: regular or statutory &

liquidity reserves

- Deposits maintained by banks with the BSP up to 40 percent of

the regular reserve requirement are paid interest at 4 percent per
annum

- Liquidity reserves are paid the rate on comparable government

securities less half a percentage point. The use of liquidity reserves
help to reduce bank intermediation costs since they are paid market-
based interest rates.

- In March 2006, the Monetary Board began to require banks to

keep liquidity reserves in the form of term deposits in the reserve
deposit account (RDA) with the BSP instead of government securities
bought directly from the BSP.

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Prof. Ragrciel Grafil Manalo 48
 TOOLS OF MONETARY POLICY

2. Rediscounting

 The BSP extends discounts, loans and advances to banking institutions in

order to influence the volume of credit in the financial system.
 Rediscounting is a standing credit facility provided by the BSP to help
banks meet temporary liquidity needs by refinancing the loans they extend to
their clients.
The rediscounting facility allows a financial institution to borrow money from
the BSP using promissory notes and other loan papers of its borrowers as
collateral.
There are two types of rediscounting facilities available to qualified banks:
the peso rediscounting facility and the Exporters’ Dollar and Yen Rediscount
Facility (EDYRF) which was introduced in 1995.
 If the BSP wants to constrict deposits and money supply, it simply reduced
the amount of funds it makes available and/or raises the rediscount rate.

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Prof. Ragrciel Grafil Manalo 49
C. TOOLS AIMED AT INFLUENCING INFLATION RATE
 What is INFLATION

Inflation refers to the rate of change in the average prices of

goods and services typically purchased by consumers. If
inflation is low and stable, then we say that there is price
stability.
Inflation is typically defined as the annual percentage change
in the Consumer Price Index (CPI).
The CPI represents the average price of a standard basket of
goods and services consumed by a typical Filipino family for a
given period.
This standard basket contains hundreds of consumption
items (such as food products, clothing, water and electricity)
whose price movements are monitored to determine the
change in the CPI, or the level of inflation.
50
C. TOOLS AIMED AT INFLUENCING INFLATION RATE
 What is the BSP’s role in relation to inflation?

- The BSP controls inflation by influencing, through monetary

policy, the supply of money circulating in the economy.

One of the main causes of inflation is excessive liquidity, or a

situation when there is too much money supply relative to the
supply of goods and services (Quantity Theory of Money). Allowing
more money to circulate induces people to increase their demand
for goods and services.

If this increased demand is not matched by higher production,

prices are bid up. Conversely, too little money to support
consumption and investment tends to reduce the demand for goods
and services. Given the same level of supply, lower demand for
goods and services causes prices to fall.

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C. TOOLS AIMED AT TARGETED INFLATION RATE
How is INFLATION TARGETING ACTUALLY DONE?
 Under inflation targeting, the central bank publicly announces a target for
inflation and promises to achieve this over a specified time period. The
central bank then compares actual headline inflation against its inflation
forecasts.
 The BSP uses the rate of change in the CPI in expressing its target for
monetary policy. Also known as the “headline” inflation rate, the rate of
change in the CPI is a commonly used and widely known measure of inflation.
 Under the inflation targeting framework, there is a need to distinguish
between the inflation target and the inflation forecast.
The inflation target represents policymakers’ desired inflation rate, which they
commit to achieve over the policy horizon (which is two years in the Philippine
case).
The inflation forecast, meanwhile, represents the expectation or prediction of
the inflation rate over the policy horizon, given information currently available.
The inflation forecast changes over time, as important new information is
incorporated in the assessment of future inflation. The forecast is a major factor
considered by monetary authorities when deciding on whether monetary policy
instruments should be adjusted to attain the inflation target.
54
 Headline inflation thus captures the changes in the cost of living
based on the movements of the prices of items in the basket of
commodities and services consumed by the typical Filipino h
ousehold.

 Core inflation measures the change in average consumer prices

after excluding from the CPI certain items with volatile price
movements.

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56
Price Stability - Inflation Targeting:
The BSP's Approach to Monetary Policy

 The primary objective of the BSP's monetary policy is “to

promote price stability conducive to a balanced and
sustainable growth of the economy” (Republic Act 7653). The
adoption of inflation targeting framework of monetary policy
in January 2002 is aimed at achieving this objective.

 Inflation targeting is focused mainly on achieving a low and

stable inflation, supportive of the economy’s growth objective.
This approach entails the announcement of an explicit
inflation target that the BSP promises to achieve over a given
time period.

 To achieve the inflation target, the BSP uses a suite of

monetary policy instruments in implementing the desired
monetary policy stance, depending on its assessment of the
outlook for inflation.

Prof. Ragrciel Grafil Manalo

57
 Price Stability - Inflation Targeting:
The BSP's Approach to Monetary Policy
 The BSP implements monetary policy using various instruments to
achieve the inflation target set by the National Government.
 To contract or expand liquidity in the financial system, the BSP can do
any or a combination of the following actions:

 raising/reducing the BSP's policy interest rates;

 increasing/decreasing the reserve requirement;
 encouraging/discouraging deposits in the special deposit account
(SDA) facility by banks and trust entities of BSP-supervised
financial
institutions;
 increasing/decreasing the rediscount rate on loans extended by
the BSP to banking institutions on a short-term basis against
eligible collaterals of banks’ borrowers; and
 outright sales/purchases of the BSP’s holdings of government
securities.
 BSP’s primary monetary policy instruments are its overnight reverse
repurchase (borrowing) rate and overnight repurchase (lending) rate.
Prof. Ragrciel Grafil Manalo 58
PUBLIC FISCAL ADMINISTRATION BETWEEN INDUSTRIALIZED
COUNTRIES AND LESS DEVELOPED COUNTRIES (LCDS)

Developed Countries = goals are more concerned

with maintaining growth and economic stability
Developing Countries = its goal is to achieve
DEVELOPMENT, or narrowly, INDUSTRIALIZATION

Prof. Ragrciel Grafil Manalo

59
PUBLIC FISCAL ADMINISTRATION BETWEEN INDUSTRIALIZED
COUNTRIES AND LESS DEVELOPED COUNTRIES (LCDS)

The current consensus is that public fiscal

administration systems in less developed countries while
visibly patterned after those of industrialized countries,
are actually different in:

 Objectives and goals

 Level economic developments,
 Historical experience, the scars and traumas of colonization
 And the politico-economic relations

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Prof. Ragrciel G. Manalo 60
VIDEO PRESENTATION ON
MONETARY POLICY AND INFLATION TARGETING

Prof. Ragrciel Grafil Manalo

61
Thank You
62
ASSIGNMENT
 Study and watch the attached PPT module and
included video for Public Finance M1 CH1
Overview on Public Fiscal Administration. Video
lecture on said topic will be uploaded for you to
watch before the conduct of our synchronous
meeting next week through the assignment tool of
your MS Teams MPCB class account.
 Afterwards, simple and logical feedback and
comment re the foregoing are required to turn in.
 Also, please be prepared for a quiz next meeting.
 For compliance. TY.

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