Stabilizing the peso exchange rate

A rapidly appreciating peso exchange rate to other foreign currencies is as damaging to the economy as a rapidly depreciating peso. So, the 20% appreciation of the Philippine peso against the U.S. dollar is already adversely affecting almost half of the Filipinos, probably causing social and political instability even as the economy continues to grow respectably. The 4 million OFW’s who are remitting to their families, at 4 dependents per family, already total 20 million; the 2 million workers of export oriented industries, especially the small and medium industries which are labor intensive, add another 10 million; the export zones and outsourcing company employees whose jobs are affected will add another 10 million; then the one million jobholders of manufacturing companies whose products are no longer competitive, another 10 million.  All in all, there are 40 million Filipinos who have experienced a loss of purchasing power or even jobs.

This is validated by the fact that the $16 billion OFW remittances is 15% of GNP,  the $34 billion export revenues is 31% of GNP, and the upcoming outsourcing industry already contributes 2% of the GNP. The griping has started and it is coming from the upper- lower class and the lower- middle class. This will eventually spread to the whole middle class, which together with the portion of the lower class will account for 40% of the population.

Part of the reason Thaksin’s party in Thailand won majority in the recent parliamentary elections, is the fact that the Thais felt they were better off when Thaksin was in power, even if the Thai economy now continues to grow at a respectable pace. Coincidental, or really better economic management, the Thai Baht at the time of Thaksin was in the 40 plus baht to the dollar,while it is now 30 to the dollar. The economic growth, then, increased employment significantly and the wealth was better distributed.

In the Philippines now, closures and layoffs are already happening in the export furniture industries and seaweed factories all over the country, and eventually all other manufacturing companies whose products cannot compete with imported cheaper products. There will be a hollowing of the manufacturing companies: they will have the capacity but no production as they will not even cover their marginal cost if they produce. Consequently, there will be more unemployed, as even the growing service sector (construction and tourism will be growing) will not be able to absorb the lost jobs in the manufacturing sector.

The strong Peso has it’s good effects, such as : lower inflation, slower increase in fuel and power prices, lower government debt and debt service, and a balanced budget for the government. But weighing these against higher unemployment in a country like the Philippines, and the consequent political and social instability, I believe it is time to stabilize the Peso exchange rate against the dollar and all major currencies.  

The Central Bank has been trying its best to mitigate the appreciation of the peso via monetary tools and market intervention. Yet it has not been as effective and the peso came out as the strongest currency in Asia in 2007. It appreciated beyond the weakness of the dollar, and against other Asian currencies of countries that it trades with and compete for exports. Even with the OFW remittances, given the import volume and value, we can surmise that there is a significant amount of speculative trade in the foreign exchange market. While it is impossible to eliminate the speculative volume in the foreign exchange market, Malaysia and China have shown that it can be reduced to a level to have an orderly management of the foreign exchange market. 

What is needed is an Exchange Stabilization Corporation (ESC), which will substantially remove the speculative activity in the foreign exchange market. The objective of this Corporation is to manage the appreciation so that it will be absorbable and livable for the economy in terms of employment and competitiveness of its industries. It will not defend a specific exchange rate, but will relate the appreciation to the appreciation of the other trading and competitive nations. China and Malaysia are two countries that are already managing well the appreciation of their currencies, and to a certain extent Japan. This ESC will  actually be similar to the Binondo Central Bank that was informally set up during Marcos time to stabilize the Peso which was depreciating very fast then. This time, the ESC will do the reverse, which is to manage the appreciation in a more transparent and credible manner. While it is impossible to prevent the appreciation of the peso, because no country can stem capital flows, it can be managed especially by a small economy like the Phillipines, because we are not “systemic,”we are not really big enough to matter much to the rest of the world economy.

The ESC has to be capitalized at P10 billion, to be contributed by the National Government, the Central Bank, and the government Financial institutions.The Central Bank will have reported a P4 billion foreign exchange loss in its 2007 financial report, which it could have put up as capital for ESC. Then, the ESC shall have the flexibility to absorb and book these exchange losses without Central Bank accounting standards.  At this level of Capitalization, with a trading band of 5%, it will have a trading clout of at least P200 billion or $4 billion. At the current daily trading volume in the Forex market of $300 million, this would be a significant amount to temper speculative activity and establish an orderly appreciation of the peso.

Fortunately, we also have the talents for this endeavor. Over the years in my work in Investment Banks, Commercial Banks, PDIC, SGV, and other financial institutions, I know that the best foreign exchange traders and dealers are Filipinos. They are employed in the top foreign and Filipino banks and they are making money for their companies, that’s why the banks are reporting record profits.

For the record, I am of the opinion that had we properly managed the Peso appreciation, it should have ended the year at the P43 to P44 range to the dollar. This would have been the less disturbing exchange rate conducive to a 7% to 8% economic growth. I am also of the opinion that the Central Bank should further reduce interest rate levels, so that all loans will be priced at single digits, at 6% for short term loans and 9% for long term loans.  Japan does not proclaim this, but part of the reason Japanese interest rates are so low is to encourage “carry trades”(borrowing low interest yen and investing in higher interest dollar or other currencies), to keep the yen from appreciating so that their exports remain competitive.

So, the Exchange Stabilization Corporation, together with the more proactive Central Bank initiatives on interest rates, a less ambitious budget deficit target (the government should spend more even if it incurs a deficit) and inflation target should prevent the peso from appreciating to the point where it will be counterproductive and inimical to the country and the wellbeing of its people.