The Bangko Sentral ng Pilipinas (BSP) is advised to hike reserve requirements in the next weeks to siphon off excess liquidity and to allow the peso to appreciate gradually, avoiding inflation from rising beyond the target.

HSBC economist Frederic Neumann said increasing the reserve requirements is the least costly vehicle in addressing the liquidity condition than tweaking the special deposit account facility which costs the BSP about P30 to P40 billion a year in interest expenses.

“Liquidity measures are not really needed now, there are so many funds in the system and they will have to go. (The reserve) hike could happen before the election and it will encourage banks to lend,” Neumann told reporters during a press briefing in Makati.

Neumann also recommends that the BSP allow the gradual appreciation of the peso. “You want to avoid locking in the exchange rate with the tightening of monetary policy. (But) there is no good solution for the BSP right now and all they could do is to decide (their actions) week by week.” HSBC expects the central bank to start cutting rates by 25 basis points in the second quarter until it has slashed off 75 basis points by the third quarter.

Neumann said the increase in capital inflows will create demand for the peso anyway and this would favor the gradual appreciation of the peso to allow for an equal gradual buildup of gross international reserves. He sees the peso trading at P43 level by the end of 2010.

HSBC also recommends that the central bank decouple its monetary policy with the US Federal Reserve in favor of a stronger peso.

“That’s the dilemma for Asian central banks the monetary policy is always dependent on the Fed. Now, we need to think about an independent monetary policy otherwise rates will be too low,” said Neumann. He expects inflation to increase to 3.2 to 5.1 percent this year.

On the fiscal side, Neumann projects the budget deficit will reach P370 billion this year or 4.6 percent of GDP from an estimated P305 billion or four percent of GDP in 2009.

The forecasts are higher than official government numbers because HSBC said the economic rebound will not necessarily have a positive effect on revenues.

“(The) challenge is the way tax system is designed since this doesn’t support growth it’s not procyclical. To improve tax collection they need to pass more revenue reforms. But I think we have to wait for next year with new administration,” said Neumann. He expects GDP to grow by 4.2 percent this year from 1.1 percent in 2009.