053107: The peso: A new model

During the past 20 years, the government has waged, through the Bangko Sentral ng Pilipinas (BSP), a financial war with only two objectives: keep inflation low and defend the peso against depreciation. The battle was fought against a backdrop of coup attempts, natural disasters, regional economic chaos, global conflicts, huge government budget deficits and a dozen other relatively minor conditions. The weapons that the BSP possessed were limited in scope and in power. Keeping the peso from running wild against the dollar was no easy task. Does anyone remember when Lucio Tan was reportedly quoted as saying he expected the peso to trade at 100 to the US dollar? A drastically depreciating peso was something that could potentially not only keep the Philippines as a basket case, but turn it into an economic “casket case.” A peso moving steadily down against the dollar could have raised the inflation rate to critical levels. No matter the possible benefit to exporters, the price on imported raw materials would have made export manufacturing prohibitive. National government foreign debt might have led to a default on payments, putting the Philippines in the same category as Mexico or Argentina. The BSP held only two viable tools to keep the peso relatively stable: foreign-currency reserves and the ability to set interest rates. Rising interest rates would make buying pesos more attractive as deposit interest would offer higher returns than in other countries. However, higher interest rates could cause the domestic economy to stall or even fall if they had to raise too much. The amount of international currency is a very important instrument to increase the value of the peso by selling dollars in the open market and buying pesos. Unfortunately, the gross international reserves have always been very small in comparison with other countries. Further, using this cash to defend the value of the peso could jeopardize the need for using this cash to fund imports. The BSP always had to walk a very thin line to keep the currency in balance. And it always did an excellent job. This is probably best illustrated in the fact that, despite all of the nation’s economic problems, the men who led the BSP, such as Mr. Gabriel Singson and Mr. Rafael Buenaventura, were very well respected and acclaimed by the international financial community. The major cause for the potential collapse in the value of the peso and the need to put close attention and careful BSP action was that there was not enough foreign currency flowing into the Philippine economic system. In the last three years, the landscape has changed virtually 180 degrees. The shifting situation creates a different set of conditions at the BSP and may necessitate a different set of objectives for it. Contrary to the basic trend of the value of the peso during the last 20 years, the peso is now appreciating. The reason is simple. More foreign currency is flowing into the Philippines because of several factors. Increasing foreign investments both in the stock market and in businesses, such as outsourcing, created large currency inflows. An increasing amount of funds is being remitted into the country to support both stock and business investments. Overseas Filipinos are sending much larger amounts of money back. Tourism in increasing, which is also increasing dollar inflows. As a result, the peso is increasing in value and, at the same time, the foreign-currency reserves of the BSP are growing by leaps and bounds. Inflation is no longer the problem that it once was. A lack of foreign money to cover imports is not a problem. The potential of high interest rates is not a problem. The problem is the potential of the peso appreciating to a point where a high-valued peso becomes a burden to the economy as much as a too low a valued peso was in the past. Without going into much detail, a high-valued peso discourages exports, reduces the country’s attractiveness to tourists and raises the cost of investing in the Philippines. However, that is not the issue here. The question is whether or not, after 20 years of fighting to keep the peso from becoming undervalued, does the BSP have the mindset, let alone the experience, to be able to change its objectives, strategies and tactics in handling the national currency? The initial reaction to an appreciating peso is that it is keeping fuel prices from rising too much, it is good if you plan to travel abroad and it reduces government debt. All true. However, the role of the BSP is to look at and adjust for the bigger and longer picture. The problems of too strong a currency can be just as significant as too weak a currency.  E-mail comments to mangun@email.com.

http://www.businessmirror.com.ph/05312007/opinion02.html