The Philippine banking system has low foreign exchange (FX) risks due to minimal exposure in US dollars, according to credit rating agency Moody’s Investors Service.
In a sector-in-depth report “Banks – Emerging Markets” released on Monday, Dec. 5, Moody’s said Philippine banks, along with banks in Vietnam, Indonesia, Chile, Cote d'Ivoire and Guatemala have the “lowest” FX risks compared to other emerging markets.
“FX risks are lowest in Chile, Cote d'Ivoire, Guatemala, Indonesia, Philippines and Vietnam. These banking systems have low levels of dollars in the system and/or their sovereigns face low risk related to FX repayments and maintain adequate foreign-currency reserves,” said Moody’s.
The peso vis-à-vis- the US dollar has depreciated to P59 on Sept. 29, its lowest level since the last one in 2004 of P56.45. With dollar selling, the Bangko Sentral ng Pilipinas (BSP) has managed to smoothen exchange rate volatilities in the past months. As of Dec. 5, the peso closed at P56.02 after regaining some lost ground at P55.74 last Friday, Dec. 2.
Moody’s said a “material exposure to currency fluctuation could expose emerging markets’ banks in these countries to additional risks to asset quality, liquidity and capital.”
The report assessed FX risks in 39 emerging markets and noted banking systems that have FX deposits that are 10 percent or more of their total deposits. Moody’s said it assessed the FX risks using two broad criterias such as structural and cyclical. It then identified which countries have very high, high, moderate and low FX-related risks.
“Emerging market currencies have lost value against the dollar. Local currencies in many emerging markets have weakened against the dollar this year amid rising inflation, higher interest rates in the US, and country-specific economic challenges,” said Moody’s.
While six emerging countries’ banking systems including the Philippines are considered as low-risk to FX fluctuations, Moody’s noted very high FX risk for banks located in Belarus, El Salvador, Kyrgyz Republic, Nigeria, Tajikistan, Turkiye and Ukraine. “All seven countries have a combination of very high levels of dollar deposits, high foreign-currency debt, weak FX reserves and/ or restrictions on capital flows,” said Moody’s.
Moody’s review included other factors that affect banks’ FX risks such as current account balance, the size of external debt and foreign-currency reserves.
“These factors play an important role in capturing the FX needs and ability of a country and its banks to service FX obligations. Other more structural and regulatory factors, such as the percentage of FX deposits in the banking system, whether the currency is pegged or free floating, whether capital can flow freely in and out of the country and any regulatory safeguards, can facilitate or hinder capital flows and banks' access to hard currencies,” said Moody’s.
In the report, while local banks have one of the lowest FX risk, the Philippines has a low current account as a percentage to gross domestic product.
The central bank’s projected current account deficit for 2022 is $20.6 billion, this is the highest current account shortfall on record, if it will happen. The BSP forecast for 2023 is $20.1 billion current account shortfall.
The current account covers trade in goods, services, primary income, and secondary income. Trade in goods such as exports and imports is the first component of the current account. For the first six months, the current account deficit was at $12 billion.
The Moody’s report also forecast that in 2023, the Philippines’ external debt and reserves will be low. The current account, external debt and reserves position affect the country’s FX cyclical indicators.
As for structural indicators, Moody’s said the country’s deposit dollarization level is also one of the lowest in 39 banking systems under review. It also noted that the country has an active de-dollarization policy while the FX regime is a “soft peg”. Capital account restrictions, meantime, is high. Moody’s define dollarization as the FX deposits as a share of total deposits.
“High deposit dollarization generally amplifies foreign-currency risks for banks. Economies with high inflation, volatile exchange rates, current account deficits and high FX debt to FX reserves tend to have highly dollarized banking systems,” said Moody’s.
Since local-currency depreciation increases risks for banks, Moody’s continue to assess its impact on banks.
“Many banks in emerging markets hold large volumes of FX loans and deposits. This is because some depositors seek protection against currency depreciation and/or inflation by switching to foreign currency, while foreign currency loans could be more attractive to borrowers because of lower interest rates on FX loans,” said Moody’s.
It added that “high dollarization causes multiple problems when the local currency drops sharply in value (and these) banks become vulnerable to an increase in defaults on foreign currency loans granted to unhedged borrowers which hurts the banks' profitability, while their liquidity and capital can also come under pressure.”