Strong peso questioned

Economists this Wednesday raised warnings on the economic impact of a stronger peso, calling for central bank intervention as the local currency continues to stay near three and a half year highs. With the peso at a little over P51 to the US dollar, the exchange rate should be brought back to last year’s P55-56 levels, University of Asia and the Pacific (UA&P) economist Victor A. Abola said. The currency’s strength, Mr. Abola told a press conference, is affecting the country’s major foreign exchange earners: merchandise exports and overseas Filipino workers (OFWs). "We cannot allow the peso to strengthen some more. It is ridiculous because as I said, our exports would be uncompetitive, and we are already uncompetitive as it is now, and our OFWs, which we call our heroes, are going to be penalized. Is that the way we treat our heroes?", he asked. The peso yesterday closed at P51.58 to $1. NO INTERVENTION The Bangko Sentral ng Pilipinas, however, said it is not intervening, and rejected talk that the peso is overvalued. BSP Deputy Governor Diwa C. Guinigundo said monetary authorities have been buying dollars from the spot market to boost international reserves, while being careful not to push up consumer prices in the process. "BSP buys forex to build its reserves," he told BusinessWorld. "This has the effect of increasing domestic liquidity which could be inflationary. But BSP has been prudent in keeping liquidity levels consistent with inflation target." "In fact, as of December 2005, [money supply] grew by only about 9% versus a high of 15% in August 2005," he added. The BSP deputy chief repeated the mantra that monetary authorities do not intervene in the foreign exchange market to prop up or weaken the peso, but only to smoothen out extreme cases of volatility. "There is no basis for saying the peso is overvalued, given the strong supply of forex (foreign exchange)," he said. "If one were to look at real rates, we are still broadly competitive." Mr. Guinigundo’s comments were prompted by rising speculation that the peso may have already overshot its equilibrium point versus the US dollar, given its sharp appreciation since the Christmas holidays. Already, the peso is experiencing stronger and stronger selling resistance as it approaches the P51:$1 level. The BSP official stressed that monetary authorities have no bias for either a strong of a weak currency, opting instead to let market forces determine the exchange rate. "[The] exchange rate is determined by market forces," he said. "We don’t defend the peso. We participate in forex trading [only] to minimize volatility of the exchange rate." Mr. Guinigundo, who heads the central bank unit supervising foreign exchange and monetary policy, declined to give additional details on how much authorities believe the peso to be undervalued. This early, sources in the government’s economic management team are saying that the interagency Development Budget and Coordination Committee will likely adjust its foreign exchange assumption for this year to a range of P51-53:$1. IDEAL LEVEL? Former National Economic and Development Authority (NEDA) chief Cielito Habito has said the peso’s ideal level should be closer to P54:$1 based on the purchasing power parity model. Using this model, the ideal level of the peso can be computed via the local inflation rate and the weighted inflation rate of its trading partners. Assuming that the inflation rate in the Philippines is 7.5% while average inflation in its major trading partners is 2.8-3.8%, the peso should be trading between P54.15 and P54.70 to be competitive, Mr. Habito said. "Below that, the foreign exchange is overvalued and it might be prudent to move in that direction," he said. An overvalued currency is deemed disadvantageous to an exporter because it means less local currency for every dollar earned. An importer, on the other hand, would look favorably at an overvalued peso because it would make it cheaper to buy from abroad. University of the Philippines economics professor Cayetano Paderanga, however, said it would be difficult to say what the ideal level should be. "I don’t think the BSP thinks that way but what it wants is to minimize the sudden drastic movements of the foreign exchange," Mr. Paderanga said For Mr. Abola, the "peso is too strong" and "is going to kill exporters." But HSBC Treasurer Wick Veloso said export numbers would disprove that forex movements directly affects the sector’s growth. A study by HSBC showed exat P3.7 billion in January 2004 when the peso was at P56.36:$1. But even as the currency strengthened to P55.77 to the dollar, exports remained strong at P3.27 billion. TAX ON OFWS Mr. Abola said the peso’s strength serves as a "tax" for OFWs since their families receive fewer pesos for the same amount of dollar remittances, which ironically, have been cited as behind the local currency’s strength. Fewer pesos, he said, mean less spending, and dampened consumption means reduced economic growth. OFW families loaded with remittances drove private consumption growth up by 5.8% in 2004. This was credited to have contributed in fuelling the economy to grow to a record 6% that year. However, private consumption growth dropped to 4.9% last year. Economic growth was 5.1%. UA&P economist Dr. Emilio T. Antonio, Jr. said merchandise exports would also be affected as exporters earn less from outbound shipments. "We expect exporters to raise a howl as their competitiveness are being eroded. Those selling in the local market would also complain about the competition with cheap imports," Mr. Antonio said. Sluggish demand for the country’s electronics products pulled down export growth for 2005 to just 3.9%, below the government’s reduced full-year target of 8%. Last year’s exports were also lower than the 14.1% growth in 2004. Lower exports also dragged the balance of trade in goods to a deficit of $3.6 billion in the 11 months to November last year. If the administration wants to wipe out the trade deficit this year, Mr. Antonio said the government can raise the exchange to an "ideal" exchange rate of P75 to a dollar. However, he admitted an exchange rate that high would be difficult to implement given the political environment. RESERVES NEED TO BE INCREASED Messrs. Abola and Antonio said the country’s dollar reserves need to be increased, saying current levels remain below that maintained by the Philippines’ Asian neighbors. The BSP has reported that gross international reserves reached an all-time high of $20.504 billion last month, up from the end-December 2005 level of US$18.495 billion. It said this level is adequate to cover about 4.3 months of imports of goods and payments of services and income. Mr. Abola pointed out that India has reserves adequate for almost 16 months of imports, while China has 15-month cushion. "Other countries have learned to protect themselves in an event of a currency attack. With our low reserves, we are susceptible to currency speculations, and we might not be able to defend the peso," Mr. Antonio said. "The illusion of a temporarily strong peso is so enthralling that our economic managers are forgetting that it is much, much better to have dollar reserves. In that way, we can be at par with our neighbors, and be less at risk in terms of ’hot money’ outflows," Mr. Abola said. - Karen L. Lema and Jeffrey O. Valisno/ BusinessWorld