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December 1, 2012 / emmanintheworld

A Stronger Peso: Effects of an Appreciating Currency

2012 is a good year for the Philippine economy.

The first half showed 6.1% growth, a massive improvement from the dismal 4.2% in 2011. Credit ratings were upgraded, the stock market posted record-breaking highs more than 30 times in this year alone, and tax collections are nearing the trillion-peso mark.

And this past week, the National Economic and Development Authority announced that the economy grew at a pace of 7.1% in the 3Q, making the Philippines the fastest-growing ASEAN country during the period.

The Aquino administration must be so proud because the numbers are proving their oft-repeated statement that “good governance is good economics.” The Philippines really looks like “it is open for business”, as President Aquino said in the ADB Governor’s Meeting in Manila.

In addition to the surprising GDP performance, the Philippine peso is continuing its rally against the dollar, making it the best-performing currency in Asia by appreciating at a rate of 7% this year. The rising peso comes from the  high levels of remittances from OFWs, foreign investments following credit rating upgrades, and the huge amount of foreign-exchange reserves held by the Bangko Sentral ng Pilipinas. These factors are keeping the supply of dollars in the market high, which dampens dollar demand.

A strong currency, however, has mixed effects on the economy, depending on who you’re talking to. For importers, it is a boon because it would mean import merchandises would be cheaper in the country because the purchasing power of the peso would be stronger. Consumers and investors would then be able to buy imported products because of their affordability.

In September 2012, imports, buoyed by higher purchases of commodities like cereals, lubricants, and other capital goods, showed a year-on-year growth of 3.6%.

A stronger peso would also be good for the government because it would mean that their debt, when converted to pesos, is lower. In fact, the government is taking advantage of this fact by buying back government bonds from past creditors.

Last month, the government bought back nearly $1.5 billion worth of dollar and euro-denominated bonds. In layman’s terms, this means that the government paid off around $1.5 billion of debt.

On the other hand, a strong peso would be detrimental to the export industry of the country. Overseas Filipino Workers would be hit by the strong local currency because the value of the dollars that they are sending their families is shrinking, amid a rising peso. With around 2 million OFWs giving their hard-earned dollars to their families, further appreciation of the local currency could translate to lower household consumption levels.

Exports are also a vulnerable sector in an economy with a rising local currency. Since the exporters’ income is in dollars, their total money would decrease in value if the peso keeps on rallying. Also, their revenue from their products sold abroad would shrink in value, forcing companies to increase their price to maintain the profit margin. Lowering the price, however, would erode the competitiveness of some product lines located in different countries.

Philexport President Sergio Ortiz-Luis told the media that the export industry is hurting and it may lead to lay-offs and closing down of shops.

With the official exchange rate already on the P40 against a dollar level, exporters, which include the booming business processing outsourcing (BPO) industry, and OFW families are telling the government to intervene and stop the rapid rise of the peso.

Although members of the central bank committee, which decides the monetary policy of the country, already announced that they will would let market forces work and only temper the rise of the peso, the national government has made efforts in raising the dollar demand in the market.

The bond buyback that the government engaged in last month also served a second purpose. By paying the foreign-denominated bonds with dollars, the government reduced the supply of dollars in the market, thereby, strengthening it against the peso. The national government is also issuing dollar bonds to the domestic market to siphon off foreign currency that is already in the hands of the public.

The appreciation and the depreciation of a currency has its pros and cons and these effects differ in magnitude, depending on the country and the multipliers in its system. The way a country is structured, whether its economy is dependent on exports or whether depends on a lot of external financing, has a deep effect on the policies the government and a central bank implements.

The lack of a specific formula to success for every country, therefore, reflects the difficulty of balancing market forces and state interventions in exchange-rate policies.

Furthermore, exchange-rate policies are not the only factors that affect the strength of a currency. The details hidden in the growth performance of an economy, whether consumption is at record levels or manufacturing grew more than the services sector, can also affect the foreign exchange market.

There is an inside lag precisely because of the many considerations officials have to take into account. This is why I believe that issues as complex as currency policies should never be sensationalized and reduced to tools to criticize the government. It is better for everyone if, instead of empty threats being thrown uselessly, a debate on the proper course of action is done.


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