When appreciation of the Peso is a bad thing

Appreciation of the Philippine peso has been always viewed as a benefit by most Filipinos having been accustomed to rapid depreciation in the 1980s and 1990s. However, with more losers than winners as a result of this situation particularly the over 10 Million OFWs working abroad, appreciation should be controlled if not reversed. Here’s one suggestion.

From BusinessWorld Philippines

By Benjamin Diokno

July 11, 2012

Stop borrowing from abroad!

The biggest threat to the Philippine economy and its huge army of overseas workers and their dependents — roughly half of all Filipinos — is the continuing appreciation of the Philippine peso. President Aquino should not sit idly by and gleefully watch the peso gain strength. The argument that a strong peso is good for Juan is not only a colossal mistake, it is also insensitive and insulting.

Here’s one bold statement that I want to see in Mr. Aquino’s third State of the Nation Address on July 23rd: “I have asked the Secretary of Finance and the heads of all government-owned and -controlled corporations to stop borrowing from abroad starting today until the end of my term. And in order to meet our foreign debt obligations, we will borrow in pesos, convert the same to dollars or yen or euro, by going to the Bangko Sentral ng Pilipinas (BSP).”

A strong peso is a curse on the families of overseas Filipino workers (OFWs), exporters and workers in the export sector, business process outsourcing (BPO) firm owners and workers, and the economy in general.

A strong peso is a curse on the National Government as its tax collection falls (ask the Bureau of Customs as it continuously struggles to meet its revenue goal) and to the Bangko Sentral ng Pilipinas as its operating losses soar.

A strong peso is a curse on OFW workers and their dependents because it forces them to send more dollars to the Philippines to keep their families on the same standard of living. Since OFW families survive on peso budgets, they need more dollars to support the same standard of living. Every time the peso appreciates in value, OFW families need more dollars for their daily needs, the education of their children, the medical bills when they get sick, electric and water bills, house rentals or the amortization of their housing loans, and so on.

For some, it means dipping into their savings abroad; for others it may mean going into debt. Both means sacrificing their bright future.

On a macro level, the impact of a strong peso on personal consumption and investment in housing is clearly negative. Consider the math: OFW remittances account for between 10% to 12% of total economic output. Assume that OFWs remittances will increase 5% (close to the Jan-April number) and assume further that the peso will appreciate 5%. Hence there will be no gain in OFW remittances in peso terms.

Assuming no change in consumer behavior, the impact on consumption will be zero in nominal terms.

But in fact it is negative. For those who had to dip into their savings and those who had to borrow money to keep the level of spending of their families unchanged, they would be poorer. In economics lingo, there is a negative wealth effect.

And, in fact, the spending behavior of OFW households has changed. Because of the gloomier world economic outlook, the political crisis in the Middle East, the economic malaise in the Euro area, and the threat of a double-dip recession in the US, OFW families are more careful with their hard-earned incomes. They are saving more (spending less), and investing even more sparingly.

The unchanged OFW remittances and the more cautious spending behavior of OFW households could put brakes on consumer spending. Both factors have also affected the medium- to low-income housing construction activity in the country.

A strong peso is also disastrous for the struggling export sector. The exports of electronic products has yet to get out of its deep, deep hole. The weak demand owing to the worsening global slowdown continues to hound the sector.

But the problem could be beyond slower global activity. It could be structural. Nokia, the once mighty telco company, is fading fast, and so are the other electronic products that the Philippines used to manufacture and export.

The BPO industry — the rising star in an otherwise dark economic horizon — is also feeling the curse of an appreciation peso. Power rates, salaries and wages, rentals and others are all paid in pesos. But the resources from abroad are in dollars, hence, the profit margins are thinning and disappearing fast.

The political noise for bringing back overseas services back to US shores is increasing. Both US President Obama and presidential challenger Mitt Romney may just be playing to the gallery in the light of continuing unemployment woes in the US. But one cannot dismiss the possibility that the move to remove all forms of fiscal incentives for locating abroad may be real.

The Philippine government is not helpless in curbing the appreciation of the peso. Both Malacañang and BSP have in their arsenal of fiscal, debt and monetary policy tool kit some measures to stem the appreciation of the peso.

Let me identify one concrete measure for each institution.

For Malacañang, as I mentioned earlier, it may declare a new policy of not borrowing from abroad.

Right now, the government is borrowing money from abroad to service its foreign debt obligations (estimated at $4.2-4.5 billion annually for the next few years). But every time loan proceeds are brought into the country, the peso appreciates. That’s supply and demand. Lower supply of dollars will help stem the appreciation of the peso.

In order to service its foreign debt obligations (interest and principal amortization), Malacañang should simply borrow in pesos, and then go to BSP and convert the pesos into dollars. That would hardly put a dent on BSP’s huge gross international reserves worth $76.2billion, equivalent to 11 months of imports.

All forms of loan restructuring should stop. The government should pay all loans that are due and demandable. With interest rates at their historic low, it would be sheer folly to postpone payment of its debts. Again, borrow in pesos and convert the same into dollars or yen or euro by going to BSP.

To the extent that the government may prepay some of its outstanding, high-costs, foreign debts, then it should prepay them now. Higher demand for dollars will help stem the appreciation of the peso. This will improve the long-term fiscal position of the government.

The BSP, on the other hand, should reduce it policy rates in order to discourage the inflow of hot money into the country. BSP sits on P1.7 trillion in special deposit accounts. The sad part is that BSP continues to pay for these SDAs, no matter how unproductive they are.

With a gloomier global outlook, coupled with a favorable and stable outlook for world food prices, there is no threat of inflation and in the near and medium-term. BSP should then turn its attention to its other mandate: economic growth.

With global economic outlook turning uglier, interest rates have been reduced to near-zero levels in the developed world. Consequently, the current BSP policy interest rates now appear to be on the high side and will increasingly be attractive for short-term overseas investments in search of higher returns.

I find it irrational why BSP should continue to pay for underutilized, unproductive funds parked in the BSP at a rate several times higher than global interest rates. The European Central Bank has recently reduced its key rate to 0.75%, the three-month London Interbank Offered Rate is 0.46%, the three-month US treasury bill rate is 0.06%.

A growth-oriented, loss-minimizing, BSP is better off reducing policy interest rates in order to induce banks do what they are expected to do — lend money for productive economic activities.

Benjamin Diokno is professor of Economics at the School of Economics, University of the Philippines (Diliman). He was formerly secretary of budget and management in the Estrada Cabinet and undersecretary for budget operations in the Aquino 1 administration.

Article location : http://www.bworldonline.com/content.php?section=Opinion&title=Stop borrowing from abroad!&id=54967

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