INSIGHT: Peso and stock market basking under the sun

MANILA, Philippines - The peso is basking in its newfound place under the sun. It is now the tiempo de vida (period of life) of the peso and the stock market is celebrating with record highs. Almost Lazarus-like, the peso has risen from the throes of death in 2005 when it plunged to 56 to the dollar. At that low point, it took 2,700 percent or 27 times more pesos to buy a dollar compared to the P2 fixed exchange rate during the14-year period from 1946 to 1959. That is how far the peso had been debased from 1960, when the first-ever devaluation occurred, up to 2005.Those 45 long years was the entire traumatic tiempo de muerte (period of death) of the peso. Now the exchange rate has recovered to 40.60 or about P15 above the low point. Very good, indeed, for a currency that was long regarded the sick currency of Asia.

The newfound strength of the peso is highlighted by the P80-billion foreign-exchange losses sustained by the Bangko Sentral ng Pilipinas (BSP) in 2011 and 2012. The intervention has only succeeded in preventing the dollar from falling too fast. It did not stop the peso’s climb. Just as it was futile for the central bank to arrest the peso’s fall in previous years, it is equally futile to reverse its rise. Clearly, the market sets the trend.

Ceteris paribus?

The strong recovery of the peso is causing discomfort to somequarters. They call for a weaker peso and measures to arrest or reverse its climb. Some policy makers and economists, understandably, prefer a weak peso to provide competitive advantage for our exports. Such support, in some instances, comes with the qualifier - ceteris paribus (all otherthings being equal). The sad reality, however, is that other things in our country are not equalwith that of many other countries.

Phenomenon: divergent currency movements, same reaction

The stock market is said to reflect the performance of the economy. On the backdrop of a strongly rising peso, which is supposed to be bad according to conventional wisdom, the Philippine stock index (Phisix) is soaring to unseen highs. It is celebrating the strong peso! Japan’s stock market, in great contrast, is celebrating the weakening of its yen. This phenomenon showing the same positive reaction to divergent currency movements attests to the stark difference between the economies of our country and Japan; that ceteris of these two countries is non paribus and a cure for one is not a cure for the other.

Peso gains, Phisix soars

Our stock market believes the strong peso is a net benefit. It is giving a strong vote of confidence with the stock index repeatedly making record highs on unprecedented P10 billion daily volume traded, and being among the topmost global stock market outperformers during the last two years. This is understandable as our export sector, which a weak peso supports, is comparatively smaller than the broader economy, 70 percent of which is consumption spending. The underlying reasons are simple. The strong peso reflects improved political and economic conditions. It dampens prices, keeps costs low and provides more purchasing power to businesses and consumers. For instance, the higher price of oil is mitigated by the strong peso. Interest cost on loans and home amortizations has dropped by half and this renders housing more affordable, which spurs the importantproperty sector. OFWs, who are home and big-ticket item buyers oninstallment-payment plan, likewise benefit. The substantially reduced interest cost compensates for OFWs’ reduced pesoearnings.

Causal relationship: exchange gains equals lower inflation

The causal relationship between currency exchange gain and inflation is well established especially in an import-oriented country, such as ours. The exchange gain results in lower cost of imported commodities, therebycausing inflation to fall. The issue is whether the correlation coefficient ofthe exchange gain and inflation is low or high. A low coefficient is bad. Itmeans price markdowns are not commensurate to the exchange gain. The reasons for that are many, i.e., imperfect competition, supply fallingshort of demand, cartelized pricing, and regulatory capture, amongothers. Here lies the challenge to agencies. Unless peso gains are efficiently translated to lower prices, the people will hardly benefit from the strong peso.

Low interest rate, growth stimulant

Despite price aberrations in some sectors, we have already seen the benefits of the strong peso through the five-year low 3.2 percent average inflation rate in 2012. Benign inflation and peso strength have provided the BSP policy space to keep interest rates at record lows. This, coupled with high liquidity in the financial system, provides a powerful stimulant for investment and growth. Corporations are raising multi-billion pesos in new capital through stock offerings and bond sales for expansion or new investment. Capital investment for newplants, component replacements or upgrades and public infrastructurenow cost less and are more affordable.

Strong peso, large capex

Record large corporate capital expenditure (capex) budgets for thecurrent year are being announced with regular frequency. The government, for its part, has also appropriated a record-high budget for infrastructure and education. Prospectively, structural impediments to economic development will be lessened. These private and public investments will vastly improve efficiency, productivity and competitiveness of our economy. All these help produce higher economic growth, more income and fatter corporate bottom lines. The local stock market recognizes all these positivefactors and rewards stocks with higher valuation.

Yen weakens, Nikkei soars

Japan’s yen, on the other hand, has recently weakened as intended by Abenomics (economic and fiscal policy of new Prime Minister Shinzo Abe characterized by printing new money, large deficit spending to stimulate the economy, negative interest rate, weaker yen and inflation target raised to 2 percent). In response, the yen weakened by 15 percent and the Nikkei stock index soared 30 percent to become among the star performers in the global stock market arena. The reason, again, is simple. Japan and even China, for that matter, has a very large export-oriented industrial base. The two countries’ immense foreign-currency denominated export earnings translate to higher yen or RMB profits when converted to their home currency and greatly boost corporate bottom lines.

Yes, a weak currency is beneficial … for export-oriented countries like Japan and China. The Philippines, on the other hand, is altogether a different story. Almost half a century of debasing the peso did not see us realize in a meaningful way the theoretical benefits of a weak currency. But it brought misery to the middle-class and the poor.  Poverty, slum colonies, sachet (mini-pack) consumption and the diaspora followed.

[Eduardo H. Yap is a CPA and property developer. He is a member of key national business organizations and author of various articles and discussion papers, such as Who is afraid of a strong Peso?, Simplifying the tax system: The way to go, and The National Budget: A broad overview, among others. Email: [email protected].