OF SUBSTANCE AND SPIRIT
Not a few market players and observers were unnerved when the Philippine peso breached ₱57 to a dollar last April 17, the lowest at that time since November 2022. It was good BSP Governor Eli Remolona tried to calm the market by saying that those movements are something we should expect from a domestic currency that is on an independent float. Nonetheless, the hit on the equities market could not be avoided. The benchmark Philippine Stock Exchange Index (PSEi) sank by more than 157 points or 2.4 percent to 6,404.97, the lowest in four months.
At first, the blame was on the US Fed Chairman Jerome Powell who was pushed in a corner by a robust economy and rising inflation that previous comments on the possibility of an early monetary easing have to be abandoned. So, risk on for higher-for-longer US policy rate which could only strengthen the dollar against other key currencies as well as those in the region.
The BSP was correct in refraining from currency market intervention because the relative weakness of the peso is regional. It will just waste precious dollars propping up the peso.
Make no mistake about it, but there are fundamental reasons for this recent movement of the local currency against the dollar.
That “higher-for-longer” argument for the peso trend to weaken is based on the need to protect that interest rate differential with the US Fed rate. The US remains a safe haven, and even if the Philippines is rated investment grade, the local risks from policy uncertainty and issues of governance are just too real to ignore. Those risks are fundamental. They can truly drive out capital to safe territories without as much of those risks.
A weaker peso is a painful result.
Unless the adjustment is sharp and volatile, and threatens inflation, no monetary action should be undertaken. Given those parameters, some currency depreciation is good for exports and foreign investment.
Geopolitical risks may have also added fuel to the fire. With Ukraine a war in progress, the Israel-Hamas war has shifted to high gear with the involvement of Syria and Iran. Their common casualties are the supply chains of this world and petroleum prices. For us, there is a potential upset of our overseas workers. Supply effects increase our dollar expense, while overseas workers displacement can reduce inflows of dollars, both of which impinge on the peso.
Closer to home, China’s bullying of the Philippines in the West Philippine Sea has stirred up a hornet’s nest. After the US and Australia expressed support for the Philippines, the foreign ministers of the G-7 declared that “there is no legal basis for China’s expansive maritime claims in the South China Sea.” At some point, some American military officials even went as far as arguing that if casualties result from China’s use of powerful lasers and water cannons, the Mutual Defense Treaty may be invoked. The hostilities could be enlarged beyond the Pacific.
Bottom line: this adds noise to the market, increases the political heat and the currency market becomes jittery.
Of course, the peso could only move within the bounds of its own fundamentals, but all these monetary and military shocks can and do amplify currency movements.
Such fundamentals derive from the country’s external payments position. Except for 2020 during the Covid-19 pandemic, our current account position has been in chronic deficit. It was no accident that in late 2022, we saw the peso climbing to close to ₱60 to a dollar because our current account position sank to a shortfall of $18.3 billion, the highest in years, in contrast to 2020’s big surplus of $11.6 billion when there was no demand for imports. The peso in 2019 averaged ₱51.8 and in 2021, ₱49.2 to a dollar. While the peso strengthened to ₱49.6 to a dollar during the pandemic, it dropped to ₱54.8 in 2022 and further down to ₱55.6 in 2023.
There is no denying that the peso could also react to any or all of the noises out there when we see the political lines being drawn between two powerful political families, or when the Constitution is to be amended beyond the restrictive economic provisions, or the macroeconomic consequences of El Niño becoming more of a reality than mere threat, or the Philippines’ ranking in various parameters of governance, rule of law, and ease of doing business sliding down.
How do we assess the peso against the other currencies?
It’s quite problematic if we were to use simple adjectives because any statement that proceeds from this could only be subjective.
One way is to check the trend of the peso’s real effective exchange rate (REER) which relates the local currency’s nominal exchange rate against two baskets of currencies, that of advanced economies and of developing countries. Calibrated by trade weights and inflation differentials, REER gives us a more comprehensive measure of the peso’s standing against these baskets of currencies. Higher inflation or appreciating nominal exchange rate increases the REER and erodes external competitiveness.
Overall, the peso’s REER appreciated in 2020 when the nominal peso exchange rate strengthened to ₱49.6, but depreciated in 2022 as it sank to ₱54.5. During those two years, inflation was at a low of 2.4 percent in 2020 and 5.8 percent in 2022. Since 2017, the peso’s REER has trended up, which means the peso was strengthening but losing competitiveness, and in 2022 it was weakening but gaining competitiveness.
Next time the peso sinks to ₱58 or ₱60 to a dollar, it will be good for our nerves to first check the REER. Unless higher inflation is risked, or the financial markets may be destabilized, let us not expect the BSP to be quick on the draw. It is more circumspect than that.