The International Monetary Fund praised the Philippines for sound monetary and fiscal policies, while saying the central bank could let the peso rise further if needed in response to capital inflows.

“Prudent policies…have underpinned a strong recovery and supported confidence,” the IMF said in its annual Article IV report on the Philippines, released Tuesday in Asia.

“The outlook for the near term is broadly favorable, but subject to significant external risks,” the lender said. “In this context, the key policy challenge is to safeguard macroeconomic stability while building the foundations for stronger and more inclusive growth over the medium term.”

The National Statistics Office said Tuesday that inflation decelerated to a 29-month low in February, as price increases in food, beverages and most other commodities moderated.

The consumer-price index, the country’s main inflation barometer, rose 2.7% in February from a year earlier, its slowest pace since September 2009, when inflation stood at 2.2%. Annual inflation in January was revised up to 4.0% from the initial estimate of 3.9%, and was 4.7% in February last year.

The central bank projected inflation in February settling within the 2.7%-3.6% range, while the median forecast of 10 economists polled by Dow Jones Newswires tipped the annual increase in the CPI at 3.3%.

Despite the easing inflation, economists doubt the Bangko Sentral ng Pilipinas will lower policy rates further, given the two 0.25 percentage point rate cuts it has implemented this year and the three-percentage-point reduction in banks’ reserve requirement effective next month.

Philippine monetary policy is “appropriately supportive” of the economy, the IMF said in its report, with inflation “firmly in the middle of the target range,” while fiscal policy is “appropriately focused” on supporting growth in the near term while curbing the budget deficit over the medium term.

The lender expressed support for the Philippine central bank’s policy of “allowing orderly adjustments of the exchange rate to market pressures.” It said, however, that the bank has “scope for further flexibility of the exchange rate in response to sustained inflows” and could draw down its ample foreign reserves, suggesting Manila could intervene less to curb rises in the peso when investors pile into Philippine assets.

The IMF said the report was based on discussions with the Philippines that ended Dec. 13.

(Story courtesy of William Mallard of the Wall Street Journal)