Falling peso, rising economy?

Is the falling value of the peso a sign of bad management of the economy? Does it signal a worsening economy ahead, and worse conditions for our people, especially the poor?

In the past, the peso-dollar exchange rate would jump when larger-than-usual dollar outflows would result from lumpy foreign payments, as when our oil companies settled their bills with the sources of their crude oil imports. A more steady rise in the exchange rate would be traced to sustained dollar outflows, as when capital exited the country because of push (domestic political trouble) or pull (better yields elsewhere) forces.

So when I started writing my last piece on the history of the falling peso, I sent a message to Bangko Sentral ng Pilipinas Deputy Governor Diwa Guinigundo, a London School of Economics-trained economist, asking which of the above might be behind the latest trends. Given his busy schedule, I would have been happy with a one-liner reply, but even while on an overseas trip, he obliged me with a copious response, which I paraphrase below.

It need not unduly alarm us that the peso is depreciating, he wrote. The latest currency movement simply reflects the fundamentals of our growing economy. The stronger outflow of foreign exchange at this time actually reflects three positive trends.

First, imports continue to surge, feeding the input requirements of our fast-growing economy, including the massive “Build, Build, Build” infrastructure push of the government. Second, Filipinos’ investments abroad are on the rise. Companies like Jollibee and Manila Water, for example, continue to expand their reach overseas, cashing in on moneymaking opportunities in the growing global economy. Third, much of the country’s foreign loans are deliberately being prepaid to avoid rising interest rates.

All these are now exerting additional demand and pressure on the local currency. We should be more scared, he pointed out, when these fundamental forces are not reflected in the movements of the peso (such as if the BSP intervenes too heavily in the market by buying or selling large amounts of dollar reserves). If the exchange rate is artificially insulated from such natural market forces, we run the risk of building up too much pressure to the point of getting large, discrete and destabilizing movements on the rate.

Reading reports of the BSP’s falling (but still very high) levels of foreign reserves, I could tell that it is selling dollars to smoothen currency movements, but not preventing it from following the natural direction dictated by the forces just cited. The bad news, as I’ve written before, is that we’ve been unable to grow our exports like our neighbors are doing; this could otherwise help arrest a longer-term depreciation trend.

Deputy Governor Guinigundo also pointed out that, in assessing the peso situation, the time frame of analysis matters. If we look at recent weekly movements, the peso indeed appears to have bucked the trend of most currencies in the region. But a five-year comparison shows us to be in step with the overall depreciation of regional currencies.

An even more meaningful assessment would consider the real effective exchange rate, tracking the peso’s movement relative to a basket of currencies of our most important trading partners, adjusted for inflation differentials. Based on this measure, he pointed out, the peso has been broadly stable because its nominal depreciation has been coupled with lower inflation in the last few years, thus keeping our exports competitive.

Finally, Mr. Guinigundo said that the pass-through effect of the exchange rate to inflation is now weaker, based on BSP tracking since it shifted to inflation targeting (vs. exchange rate targeting in the 1990s) in 2002. This means that the economy has become more efficient and competitive, thereby moderating the exchange rate movements’ impact on domestic price levels. Thus, while the falling peso helps exporters and their workers, along with families dependent on remittances from abroad, it would not hurt the rest of us as much as it would have before, via higher inflation.

Fear not, then: The falling peso doesn’t mean the economy is falling, too.

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