OF SUBSTANCE AND SPIRIT
Diwa C. Guinigundo
Seals of approval for sovereigns like the Philippines are difficult to obtain.
International financial institutions (IFIs), credit rating agencies (CRAs) and foreign investors would usually scrutinize our ability to withstand global shocks. While globalization has brought about positive outcome including more open trade and investment, the Great Divide between and among nations has actually widened. As Joseph Stiglitz once said: “If globalization has not succeeded in reducing poverty, neither has it succeeded in ensuring stability.”
It is no exaggeration to say that the seeds of the two recent crises that were first nurtured in some countries finally broke out like today’s pandemic wildfire and scattered globally. Financial contagion was amplified by the infrastructure of globalization. The benefits of globalization that expand both production frontiers and markets could be outweighed by the devastation of job opportunities and social alienation when something goes wrong in one big economy.
So IFIs and CRAs have to check our ability to roll with the global punches. It is costly if they err before formalizing their positive endorsement of our economic prospects. Investors rely on third-party assessment apart from their own due diligence. They need to focus on those factors that generate both tenacity and resiliency. One factor is the flexibility of our exchange rate.
With open borders for capital flows, keeping the exchange rate fixed or essentially managed may not be effective because market volatilities could build up pressure so discretely large it could destabilize. We found this the hard way during the 1960s and 1970s when we all suffered the consequences of devaluation. With little support from structural reforms, exchange rate adjustments are nothing but band-aid solution.
We managed the exchange rate but our efforts were not up to the tumultuous events of the 1980s. We lost the ability to service our foreign debt and declared moratorium after Argentina and Mexico defaulted on their external debt. This caused a global fear of emerging markets’ insolvency and therefore inability to honor their obligations.
In the Philippines, we shifted to an independent float after the Asian Financial Crisis. We succeeded in avoiding large, discrete adjustments called devaluation when the peso is fixed. The peso has been moving in both directions on a daily basis especially since we embraced flexible inflation targeting (FIT) in 2002. Despite these fluctuations, we managed to keep inflation generally low and stable during the FIT years.
This was duly noted by the macroeconomic assessors.
Confidence mounts when the authorities limit their FX intervention to smoothing FX market volatilities. We adhere to the proposition that it is nearly impossible for the monetary authorities to engineer a weak peso to help exports, outsource companies and OFW remittances. BSP cannot do battle against rising inflation that pulls down external competitiveness and also continue buying dollars from the market, flooding it with pesos in the hope of keeping “the peso weak.”
Price stability is the primary mandate of the BSP, not export competitiveness. When prices are stable, even exporters and OFW families should get more from each peso equivalent of remittance.
Flexible exchange rates foster confidence only when public policy is sensible. Many central banks would blame speculative markets rather than the patently misguided public policy, as Paul Krugman would argue. Fouling up public policy fosters market disorder and mistrust of authorities.
The other factor is the adequacy of our gross international reserves (GIR). This is the subject of our last week’s column. While “it seems patriotic to convert part of reserves and allow its use for funding cash transfer or infrastructure,” reserves are not cut out for development financing. That is the job of fiscal policy. Reserves are for emergency use against global shocks.
Nobody wants the independence and the credibility of the central bank undermined. Argentina learned this lesson the hard way.
We might find ourselves stepping back to 2012. At the time, Europe was in virtual conflagration with deep recession, high unemployment and inability to service foreign debt. There was an uncanny threat of a global spread of Europe’s economic woes. The world was still smarting from the global financial crisis.
This prompted the IMF to raise $600 billion from its qualified members to establish the European firewalls, stem potential contagion and secure global economic and financial stability. The funds were to be relent to affected European countries, drawn only when needed, and repaid with interest.
With strong BOP and 13 years of uninterrupted growth, we were invited to participate by pledging $1 billion or 1.3 percent of our reserves. This was and remains consistent with the BSP charter which limits the use of reserves for contingency and international lending and investment operations. Around 40 countries participated in the pledge including Malaysia and Thailand.
We clarified to civil society that our exposure was to the triple A IMF rather than to several European countries which were downgraded by the CRAs. It was a simple case of diversifying reserves, managing risks and maximizing returns.
The Philippine pledge was never drawn down. Yet this international show of cooperation coupled with reforms in Europe was enough to forestall an otherwise global crisis. It’s difficult to imagine a scenario where countries do not have enough reserves to calm the markets.
Big reserves help fortify our defense against global shocks. Big reserves also strengthen confidence in our ability to roll with the punches.