Peso… the weakest currency in Asia

This week’s article is a follow up to Philequity’s press release last Wednesday. Philequity came out in the front page of The Philippine Star and was quoted as saying that "the peso will likely go back to 56.50 against the US dollar if talks of amending the EVAT law are prolonged or if indeed the VAT on oil and fuel is suspended." But hours before the paper was even published, Malacañang clarified that it would not be tinkering with the EVAT implementation.

We would like to commend the country’s economic team led by Finance Secretary Gary Teves, Trade Secretary Peter Favila, BSP Governor Amando Tetangco Jr., and National Treasurer Omar Cruz. While the peso has already reacted negatively on proposal, the economic officials’ quick action to assure investors – that the country is sticking to its fiscal program – averted dire reactions from the financial markets and credit rating agencies.

Nevertheless, from being the strongest currency in Asia last year, the Philippine peso performed poorly last month, closing at 51.785 against the dollar. From the table below, we can see that whereas Asian currencies and major currencies have rallied strongly against the dollar last month, the Philippine peso did the reverse. For the month of April, the peso fell 1.3 percent, while other Asian currencies, such as the Thai baht is up 3.4 percent, the Indonesian Rupiah is up 3.3 percent, and the Korean Won is up 2.9 percent. Meanwhile, the major currencies performed even better against the dollar, appreciating an average of 4.7 percent.

Why the peso is weak?

The following are the reasons why the peso is currently weak vis-à-vis Asian and major currencies:

1) Apprehension over the suspension of EVAT on oil and oil products. Any change in the EVAT law, wholly or partly, sends a very bad signal to investors as this will show that the government is indecisive and populist. The proposal alone has already weakened the peso. If pursued, the government stands to lose P29 billion or roughly 40 percent of the P75 billion expected proceeds from the EVAT-led tax reform package.

2) BSP supporting the dollar at P50/$1. Despite the recent peso weakness, we must note that it is still up 2.5 percent year-to-date against the dollar. In fact, the peso sharply appreciated near our year-end objective of P50/$1 just in the first few months of the year. We continue to believe that this is the level that BSP will start supporting the dollar so as not to create to much imbalance as to hurt our exporters.

Aside from buying dollars in open market operations, the BSP is also indirectly supporting the dollar by keeping its key policy rates steady despite increases in US Fed fund rates (refer to our article BSP firmly at the helm -Philequity Corner, April 10, 2006). Since 2004, the US Fed has had 15 successive quarter point increases in its Fed Funds rate totaling to 3.5 percent, while the BSP had increased its rates by just .75 percent over the same period.

3) SC ruling on EO 464. While the Supreme Court may have resolved the constitutionality of Executive Order 464, the rift between the Senate and the executive will likely worsen as members of the opposition are expected to immediately embark on a series of legislative inquiries. Although the financial markets has so far disregarded politics and has focused solely on economic fundamentals, continued political bickering will likely have an effect, albeit minima.

4) Narrowing interest rate spreads against US Treasuries. Lastly, but more importantly, the peso’s recent weakness is attributed to the narrowing of interest rate spreads against US Treasuries. Note that the lowering of the country’s sovereign risk premium, primarily as a result of the EVAT implementation, has resulted in a sharp decline in local bond yields. The yield on the 10-year ROP, for example, has declined from 8.2 percent in Sept. 2005 to 6.8 percent as of last week. Meanwhile, the yield on a comparable 10-year US Treasury Note (which is currently at its highest since 2002) has risen from four percent to 5.1 percent over the same period. Thus, the spread has narrowed sharply from four percent to 1.7 percent in just seven months.

The narrowing of spreads is even more apparent in shorter term Treasury bills with the 91-day Philippine Tbill rate at 4.993 percent compared to the three-month US Tbill rate of 4.65 percent. So long as this narrowing of spreads continues, the relative attractiveness of holding peso assets versus dollar assets will likely be reduced. We believe, therefore, that there is room for the BSP’s Monetary Board to let its key policy rates inch up a bit without so much as stunting economic growth.

Oil price mitigating measures

We support the move by our economic officials to cut the tariff on imported petroleum products instead of suspending the VAT on oil to mitigate the impact of high crude oil prices. We also support Trade Secretary Peter Favila’s proposal to consider implementing Daylight Saving Time (DST) and other measures such as cutting mall hours to lessen the impact of high oil price by reducing the energy consumption. The acceleration of the use of alternative fuels such as LPG, coco-biodiesel and ethanol, and the fast-tracking of the enactment of the Biofuels Act of 2006 and the Renewable Energy Bill are also steps in the right direction.

Disclosure: In the April 17, 2006 column, a footnote disclosing that this writer is chairman of the board for both iVantage Corp. and e-Business Services, Inc was inadvertently omitted. 

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