OF SUBSTANCE AND SPIRIT
During the weekend, the broadsheets reported that the Philippines’ foreign exchange (FX) reserves slipped slightly to $107 billion in end-May “as the National Government (NG) spent more to bankroll its COVID-19 response measures and paid more foreign loans.”
First things first.
We should clarify that the government covered its COVID-19 expenses using its own FX deposits with the BSP. Proceeds of NG’s foreign loans or global bonds are deposited with the BSP and are counted as part of reserves. Foreign debt repayments were also sourced from its deposit with the BSP.
But not all FX reserves belong to NG. Only when the NG borrows from abroad in FX and deposits the proceeds with the BSP that it gets to own part of the reserves.
What happened in 2020 was interesting. With lower imports and higher proceeds from foreign loans, the BSP’s dollar reserves surged in 2020 in contrast to the depth of the economic recession.
Managing FX reserves is an important responsibility of the BSP, and for that matter, for all central banks around the world. Section 65 of the BSP Charter explicitly provides that the BSP shall maintain its FX reserves to meet any unexpected net FX demands on the BSP and in the process, keep “the international stability and convertibility of the Philippine peso.” FX reserves are only for reserve purposes, like in a crisis which could motivate sudden stop of capital flows or even capital reversal. When the currency is under attack, the central bank could immediately dip into reserves to calm the market.
While not in use, FX reserves are invested abroad, or lent to international financial institutions in accordance with its Charter. Section 66 mandates the Monetary Board to keep the reserves of the BSP in “freely convertible currencies.” The BSP cannot keep its foreign reserves in domestic assets and hope against hope that when the need arises, it could immediately convert its peso assetsto FX.
This is the reason why the BSP should keep its reserves in short-term, fully-convertible foreign assets. Investing the reserves in long-term development projects in peso will contravene the legislative intent of maintaining international reserves, unless Congress amends the BSP charter again. This is neither good for national security, nor for central bank independence. Central banks do not do development financing.
It sounds insane to keep $107 billion in FX reserves which translates into 12.2 months of imports of goods and services when some metrics for the Philippines would prescribe only around $60 billion in “adequate” reserves or 5-7 months of imports of goods and services. But it’s not the standard setters who will be held accountable, it is the central bank.
Global interest rates on FX investment are ridiculously low, it seems patriotic to convert part of reserves and allow its use for funding cash transfer or infrastructure. The problem with these metrics is that they ignore the reality that developing and emerging markets are more prone to market volatilities.
Using reserves to fund infra projects sounds sensible but central bank reserves are not cut out to do this. Reserves are for contingency if everything else fails.
This potential conflict between an independent central bank and a central government could turn ugly.
Martin Redrado, former president of the Central Bank of Argentina, lost his job at the central bank, attempting to uphold its independence. Former Peronist President Cristina Fernandez de Kirchner, successor to her own husband Nestor, wanted the central bank to transfer $6.7 billion out of its $50 billion FX reserves to the treasury to finance higher public spending and service foreign loans.
Redrado categorically advised the President that the reserves could not be used to finance public spending. Argentina should go out and borrow. He described the request as “looking for short cuts.” Argentina could show that during the global financial crisis, it did not default and the Argentine peso was not devalued.
To force the issue, Kirchner caused Congress to issue a DNU — Decree of Necessity and Urgency — which fell short of the threshold of necessity and urgency, as required by the central bank’s constitution.
Redrado’s defense of the proper use of central bank resources and therefore, central bank independence, did not happen only once but many times.
As central bank president from 2004 to 2010, Redrado served both husband and wife. In 2006, Nestor asked him to use reserves to buy an oil company. In 2007, he was asked to check if infrastructure could be financed by reserves. In 2008, Nestor instructed Redrado to pay Argentine debt to the Paris Club with reserves. In 2009, he was asked to place compulsory bonds on domestic banks for their share of dollar deposits. Redrado rejected them all.
While Redrado and the opposition members of Congress fought the last straw, an impasse forced Redrado to just resign in 2010.
How did the long story end?
BBC News reported that Redrado in 2015 described the end of Kirchner’s eight-year presidency: “When I left the Central Bank there were $50 billion, real dollars, liquid dollars… now we are left with net reserves of just 10 percent of that. Basically in the last year, they decided to use it all, so the bill is left for the next president.”
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