doomed dollar exchange

i had been trying to get a grip on the problem of the rising peso, trying to understand why it is said to be good for the economy when it’s clear na mas maraming pilipinong nagigipit kaysa naliligayahan. googling didn’t bring up more than the usual reports about negatively affected sectors, such as telecommunications, manufacturing, garments, real estate, and of course about ofws and their nixed appeal for a fixed exchange rate and lower remittance fees.

but now that the exchange is up (down) to 40-something pesos to a dollar from 49-something in january 2007, hindi ba tayo dapat mabahala? so i emailed two economists, cielito habito of inquirer whom i know personally (a sister of his married a brother of mine) and filomeno sta. ana iii of business world whom i “met” through the plaridel e-group, and asked them what the government could do to stop the peso from appreciating so much.

i thank them both for their quick replies via their monday columns. habito’s Dealing with the rising peso (which has a part 2 that he emailed me a capsule of) and sta. ana’s Temper the appreciation, says GMA. Is that enough?

as it turns out habito and sta. ana are on different wavelengths, representing two different schools of thought.

habito, neda director-general in fvr’s time, agrees that there are things government can do but fixing the exchange rate is not one of them.

“Defending a fixed exchange rate (that is, making it stick) under current circumstances requires measures that would raise demand for or reduce supply of foreign exchange. The Bangko Sentral (BSP, the Philippine central bank) itself would inevitably have to provide most of the needed extra demand, by buying up increasingly large amounts of dollars. While this may look good because it wouldbuild up the country’s foreign reserves, it can have at least two harmful effects. One, it pours pesos into the system, thereby stimulating inflation (i.e., accelerating price increases). Wonder why inflation has ticked up lately? Well, oil prices are not the only reason, that’s for sure. Two, it would lead to large financial losses on the part of the BSP, losses that must ultimately be shouldered by someone (there’s no free lunch!).

“The latter has in fact already been happening, even without fixing the exchange rate. In the course of trying to arrest a too-rapid peso appreciation, the BSP has quietly built up foreign reserves over the past year from about $23 billion in January to more than $33 billion by year’s end. This means that it has been accumulating massive amounts of an asset that is rapidly losing value, leading to losses estimated at over P40 billion so far. Remember the old Central Bank and how it ran up massive losses in the late ’80s and early ’90s from exchange rate operations (of the reverse kind)? After it was reorganized by law into the present BSP, we taxpayers ended up quietly paying for all that, in case you didn’t know.”

instead, habito would recommend taxing “hot money” and encouraging capital flight.

“I’ve written before that Thailand and Taiwan, among other countries, have … eased up dramatically on the rules on foreign investments by their citizens, practically abetting it. At the same time, they are restricting entry of portfolio investments (“hot money”) to curb supplies. Some people in our government still think it’s a good thing that we are able to attract a lot of hot money, unfortunately. Not because they are benefiting, but because they don’t know any better, and argue (for pogi points) that it’s a sign of (misplaced) confidence in our economy, etc. Actually it’s not a “pull” factor at play here but a “push” one, as I’ve been pointing out. There’s simply so much dollars out there — nobody wants them — looking for a place to go.

“I personally see very limited leeway for our government to influence the exchange rate in the face of global market forces (i.e. the weak dollar, which will soon be further weakened by the anticipated lowering of US interest rates by the Fed), plus the surging
remittances of OFWs, which is a natural response to the declining peso value of their remittances (i.e. in an effort to maintain the peso incomes of their families at home).

“… In a sense, we are helpless on this, and can only do palliative measures for those affected at best. I think our economy should learn to adjust to a lower peso-dollar exchange rate in the long run. The trend will continue until the US economy turns around, and I don’t see it happening under Bush because of his expensive Iraq adventure.”

sta. ana, who belongs to a reform-oriented activist policy group (Action for Economic Reforms), believes that more can be done.

“Time and again, we, together with many economists like Raul Fabella, have advocated a competitive exchange rate. Even the World Bank and the International Monetary Fund favor a more competitive exchange rate.

“What a competitive exchange rate is is debatable. At the very least, the Philippine peso should not be overvalued. We estimate that the overvaluation of the Philippine peso is about to reach 15 percent. Recall that a factor behind the 1997 financial crisis was an overvalued peso. We have not yet reached that degree of overvaluation in 1997, but the current trend is already a cause for alarm. The Bank of the Philippine Islands (BPI) forecasts that the exchange rate may even settle at PhP37 per US dollar.

“But like Fabella, we are not content with simply avoiding overvaluation. More importantly, we prefer an undervalued currency. For this is the lesson of the successful developing countries; an undervalued currency is a necessary condition to achieve sustained high-growth rates over a long period. Empirical studies have confirmed this. Dani Rodrik, for example, estimates that an undervaluation of 50 percent (which is roughly the undervaluation of the Chinese renminbi) translates into a contemporaneous growth boost of 1.35 percentage points.

“In the past, an advocacy for an undervalued currency was a lonely battle. Devaluation has been associated with economic crises. Thus, those who prescribe depreciation face what Fabella calls a ‘credibility wall.’

“But precisely, devaluation was a corrective measure in light of the significant overvaluation of the peso. We would not have been struck hard by the 1997 financial crisis, if the peso was not overvalued in the first place.

“But this time, the public is learning that an appreciating, overvalued currency hurts the whole economy and many sectors. Now, the media reports attribute the closure of 75 firms in the first half of 1997 and the displacement of 100,000 workers in the seaweed industry, to the appreciating peso.

“There is now an expanding constituency, organized and articulate, for a competitive exchange rate, which is our euphemism for undervaluation. It is composed of the organizations of manufacturing exporters, food processors, business process outsourcing, workers, overseas Filipinos, together with public interest groups and academics. Even the protectionists favor a devalued currency as a substitute for trade protection.”

of course, undervaluing the peso, maybe back to 50? 55? would require a change of policy, which seems unlikely, given GMA’s mindset that an appreciating peso is good because it takes fewer pesos now to pay off our dollar debts, which she has been gleefully doing just so she can borrow some more. masaya siya.


  1. I believe that the BSP had been dipping its hands in the currency trading. What they failed to foresee was the adverse effect it has on a greater number of sectors. They thought that the with their meddling, GMA and her team could use it to boast of a progressing economy.

    The inflation you mentioned had begun mid last year. Couple that with the hot money during the elections, the bubble is bound to blow.

    Btw, the article Nick Joaquin wrote which I republished is but a portion of the bigger picture. You are right, there is an article which also included how the Arroyos and their allies plotted to oust Erap. They began planning as early as 4 months after Erap took the presidency.

  2. Thank God, there’s finally one blogger who dared delve into the “crisis” of the appreciating peso.

    While some listen with open-mouthed awe at the fantastic economic figures, either because they are all totally lost in the leaders’ high-falutin economic geekspeak, or simply dismiss high finance as way out of their league, very few respectable dissenters have actually made their counter-analysis public. That is understandable. In business, the status quo is always preferred, most especially when personal financial interests are on an upswing. Or hopefully going there.

    These articles by Habito and Sta. Ana are most welcome inputs in providing a balance of views, the positive of which, lately, are all coming from government.

    It gives investors, analysts, and managers more tools in his trade to make a better judgement. I myself see this situation more in a negative perspective. Hedge funds in the US that are suffering (or are smarting) from the current subprime mortgage meltdown are raring to train their sights overseas to recoup lost investments. And overvalued currencies such as the Philippine Peso are ripe for the picking.

    Short-selling in currencies were made fashionable by George Soros’ Quantum Fund when he broke the Bank of England in 1992 – Black Wednesday, it is now called. He sold short $10B worth of Sterling Pounds to prove to his investors that his research on the weakness of the currency would make them at least half a billion dollars. After closing his position, he walked away with more than one billion dollars, forcing Bank of England to adjust its interest rates and devalue the currency, which Soros believed it should have done way back.

    That’s precisely the situation we are in today. Short selling works this way:

    A fund manager gets a loan of P40B and buys $1B from the market, which is roughly today’s exchange rate. The manager, being sure that his figures are right that the Peso is overvalued, will hold his dollars until such time that the corrected exchange value prevails, let’s say P50=$1, a difference of P10, that’s the time he pays his loan. He gets to pay his P40B loan and makes P10B (50B minus 40B) profit which he then distributes to his investors at a predetermined date.

    The “segurista” attitude of the Philippine financial markets, I guess derived mainly from the characteristic of many big bank owners who are of Chinese lineage, prevents the industry from assuming the many available vehicles to prevent such vicious currency attacks, or in a subtler term – speculations, I pray won’t happen if the BSP would be true to its mandate.

    The $10B increase in reserves gives me the chills. Habito is right, we are accumulating an asset that is fast losing its value. We might just end up holding an empty bag.

    The bottomline, when it occurs, we, the “investors” in Phils., Inc. would all have to shoulder the losses, again.

  3. The benefits of devaluing the peso indeed sounds good but Sta. Ana’s reply failed to address how to go about it. As explained in Habito’s reply, devaluing the peso means holding foreign reserves which ultimately leaves taxpayers footing the bill; hence it is an indirect form of taxation. Everyone losses for the benefit of select sectors of the society like people employed in export industries and families of OFW’s. Hardly consistent with socialist-democratic agenda espoused by the critics of this adminsitration, isn’t it?

    Yes, empirical studies suggest that currency devaluation is appropriate for a developing country. But in those developing countries (eg Malaysia) when they fixed their exchange rate, are conditions similar to the Philippines with (a) huge public debt in foreign currency; (b) service-oriented economy; and (c) huge dollar remittances?

    GMA can fully arrest the peso appreciation by directing the BSP into unloading their peso into the market. But this move will hike inflation, as have been noted by Habito, with even relatively small attempts by the BSP. GMA, who is a firm believer in Keynesian economics, is therefore unlikely to support it.

  4. so, schumey, tongue, arbet, carl: seems like the u.s. recession has really kicked in? peso is down a little. will this continue, do you think? i’ve been reading that remittances are expected to go down as people lose jobs…

  5. Historically, recessions in the US average a span of 10 months. I’m not sure when this one actually started, if at all.

    Regarding remittances, it’s technically infirmed that OFW remittances is even considered by your favorite pseudo-economist GMA as a factor in measuring her economic policy effectiveness. There’s the reason this amount is not included in GDP computations. That is money generated outside the of the operational control of a country therefore, government does not and should not get credit for it!

    But you may be correct that people may lose overseas jobs, we all know that US-based OFWs form the biggest slice of the remitted money pie. BUT if recession actually happens, and as you say jobs are lost, those who were saved from the chopping block will have to remit more to sustain their families back home with its new additional dependents.

    We’re still lucky, however, that almost half of our exports are for the Asian region, and our plants that export to the US are either scaled-down or have earlier moved to China and Asean, we are less “worried” of a US recession unlike perhaps, Mexico and South America.

    I’ve not checked the US data yet, but to answer your question if recession has kicked in, I will have to say yes, because technically, a few months into the negative region and no good news is in sight, my fearless forecast is that a turnaround may only happen next winter, to coincide with the turnover of the White House keys to a Democrat President.

  6. Everyone losses for the benefit of select sectors of the society like people employed in export industries and families of OFW’s. Hardly consistent with socialist-democratic agenda espoused by the critics of this adminsitration, isn’t it? -Carl

    As I would agree with most of Carl’s points, I can’t say the same with this one, though. Developed Nations were built with a strong industrial base. It provides the necessary number of jobs that prevents brain drain and in the long run, promotes local competition that results in better quality and lower prices. And if you look again, that present number – exporters and OFWs (Carl missed slashed Fils waiting to retire with their Euros and Dollars) – are in no way an insignificant number. OFWs alone, last counted at around 8Million, and an average family size of six or five roughly make up half of the total population, add to that the workers in the export industry and their dependents is easily a majority, right? It may in fact fall within the popular socialist agenda.

    A robust local economy anchored on strong and dynamic integrated industries (I don’t buy the crap that agriculture, the one-hectare per farmer kind, will be the cure-all), and industrial sized agri-business working side by side would be it.

    Not this human export (now including internal parts thereof) that the government shamelessly rides on and even takes credit for it.

    That’s Gloria and her Keynesian economyths.