OF SUBSTANCE AND SPIRIT
It was timely for the Bangko Sentral ng Pilipinas (BSP) to have further tweaked its hedging facility to mitigate what could be a sharp depreciation of the peso against the US dollar. Currency hedging is like having insurance to protect corporates against possible losses due to foreign exchange (FX) movements. Uncertainty cannot be avoided, but it can be mitigated.
Corporates face all sorts of external headwinds with deep impact on international trade. The hostilities in Ukraine could be prolonged with far-reaching implications on global value chains, economic growth and inflation. Here in Asia, proxy wars could be anything but stabilizing, and investors hate uncertainty. Capital flows across borders could likely upset the cash flow of companies through FX volatilities.
Yes, S&P Global Ratings opined that the 380 or so banks and non-bank financial institutions that they rate in the region are resilient to absorb the so-called knock-on effects of the Silicon Valley collapse. But short-term FX movements may have negative short-term damage to their profitability.
Good if every market player could employ dedicated team of currency watchers to nimbly reconfigure their business strategies. Yet financials are likely to be affected in the transition. All up, it makes sense to simply take out insurance. By limiting the risks on financial assets, hedging buys protection and possibly, peace of mind.
BSP Deputy Governor Chuchi Fonacier was therefore correct in saying that this hedging facility known as Currency Rate Risk Protection Program (CRRPP) is a continuing facility that offers a non-deliverable dollar/peso forward contract (NDF) between the BSP and the banks. This will help bank clients cover their eligible FX obligations by effectively locking the exchange rate to a pre-determined level at a future date.
The use of NDF is appropriate because the underlying FX obligations are short term, allowing the settlement of only the net difference between the contracted forward rate and the prevailing spot rate in pesos at maturity of the contract. Hence, the demand for FX and the impact on the exchange rate are minimized.
We recall that we helped organize this program in January 2005 when the peso was inching closer to ₱56 to a dollar. We consulted with the market, both corporates and the banks, and on Jan. 17, 2005 the BSP issued Circular No. 470. This was subsequently enhanced by Circular No. 1014 dated Sept. 24, 2018 and Circular No. 1015 dated Oct. 5, 2018.
What caused this FX dynamics?
This should sound familiar.
After the dot-com recession in the early 2000s, the US economy showed extraordinary strength. Economic recovery was rapid with the US Fed slashing policy rates down to only one percent. A year earlier in 2004, real GDP expanded from 1.7 percent in 2001 to 3.9 percent. When the market started talking about a looming bubble especially in the housing sector, the US Fed was quick to start tightening monetary policy by a series of 25 basis points. As a result, emerging markets and developing economies, including the Philippines, experienced severe capital outflows with negative impact on both the exchange rate and domestic inflation.
In the case of the Philippines, the exchange rate pass through at the time remained relatively large, having shifted to flexible inflation targeting only in 2002. Inflation climbed to 6.5 percent in 2005. But actually, the aggregate availment under the program was not large. Yet it helped calm the market and that was all that mattered.
Before the tweak this year, the CRRPP qualified unhedged FX obligations amounting to at least US $50,000 that were both current and outstanding as of the date of application. They included, but not limited to, BSP-reported trade-related loans from resident banks, FX deposit units, regular banking units, offshore banking units and offshore banks — short, medium and long term — and US dollar trust receipts.
Market-driven, the CRRPP allows the banks to transact with the BSP through Bloomberg or Reuters daily. Quotes are published by the BSP’s treasury for one, two and three-month tenors. Pricing is transparent with the formula indicated in the circulars.
This year’s enhancements expanded the coverage of the program to include non-trade transactions and resident-to-resident FX transactions including outward investments. Documentary requirements have been simplified by aligning them with current FX transactions and eliminating the notarial rules for speedy transactions.
This BSP move was wise on two fronts.
First, as BSP Governor Philip Medalla stressed, “spillover of risks is inevitable in an increasingly global and interconnected world.” Enhancing the CRRPP expands the access of market players and effectively restrains possible speculative play in the FX market. While it’s a continuing facility, the market has to be reminded that it exists, its coverage expanded and the rules simplified. This should help disappoint talks about the peso hitting ₱60 to a dollar.
Second, with a limited pass through to inflation, a well-behaved peso reduces the pressure to sustain monetary tightening. Keeping monetary policy at 6.25 percent appears reasonable considering its latest inflation forecast of six percent for 2023 and 2.9 percent for 2024. Although real policy rate is now positive, we need to bear in mind that it may need further adjustment because of one, the US Fed could sustain monetary tightening; two, inflation risks continue on the upside; and three, the risks of lower growth are emerging. The CRRPP serves to address the inflationary contribution of a weak peso and allows more latitude for monetary policy to focus on price stability.
Mark Twain was right that while history may not repeat itself, it does often rhyme. May we not run out of bright ideas now and in the future.