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Economy

Strong forex inflows now hurting economy - BSP

November 18, 2007 6:13pm

Monetary officials warned that strong foreign exchange inflows were beginning to cause stress on the Philippine economy that would require immediate intervention.

Preliminary studies by the Bangko Sentral ng Pilipinas (BSP) indicated that the economy was beginning to show early symptoms of the so-called Dutch Disease, which could result in the sharp contraction of the economy if not addressed properly.

According to Cyd Amador, BSP managing director for monetary policy, evidence suggests that remittances, in particular, could be setting off a cycle of ultimately negative side effects of strong forex inflows.

After the appreciation of the currency and the immediate loss of competitiveness, Amador said the other symptoms show up as a slowdown in the production of traditional tradable goods, the shift of labor demand from the booming sector to the lagging sector and the increase in the price of non-tradable goods against tradable goods.

"There are other factors that affect the competitiveness of our products exported abroad," Amador was quick to point out. "But the real appreciation of the peso has started to be apparent in 2007, when compared to other currencies in the region."

The so-called Dutch Disease broadly refers to the harmful effects of large inflows of foreign currency, beginning with loss of competitiveness that could ultimately trigger a decline in the manufacturing sector.

The concept was first described after The Netherlands discovered natural gas in the 1960s and saw a marked decline in the manufacturing sector as the economy shifted focus toward the development of its natural gas resources while losing its foothold in its traditional exports.

According to Amador, the BSP had already looked at whether the same phenomenon was beginning to show because of strong forex inflows from investments and remittances but she said the first analysis showed no sign of the disease.

However, Amador said the most recent modeling she conducted had shown initial indications of a real appreciation of the peso against a basket of currencies that include the country's main competitors in the world export market.

"The peso has been appreciating steadily together with currencies in these countries," Amador said. "But in 2007, we began to see a modest increase in the real exchange rate, indicating some relative reduction in external price competitiveness."

Second and more importantly, Amador said her models showed a decline in the share of the tradable goods sector, including manufacturing to total output. This was also accompanied by a decline in the sector's share in total employment since 1996.

"These developments could be symptomatic of the contraction of the manufacturing sector associated with the Dutch disease," Amador said.

Amador said the prices of tradable goods have also lagged behind the prices of such non-tradable goods as construction, electricity, water and services.

"On the other hand, the prices of tradable goods could not move because these prices are set in the international market," she explained. "That means wages in the export sector can not go up because that will affect their competitiveness too."

However, Amador said the symptoms were detected early enough and could still be very easily addressed by diversification of the country's product and labor markets.

Amador said it would also be critical to direct foreign exchange inflows toward productive activities to boost productivity in the non-tradable sector and help retrain workers in the lagging export industries. - GMANews.TV
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