Depreciating

There is no “correct” exchange rate. The values of currencies rise or fall due to a myriad of factors: interest rate decisions, gross international reserves, confidence in the domestic market, speculation, etc.

The peso is about to cross into the $1:P55 territory. To some this is good news; to others it is a terrible turn.

Let it be clear, however, that the peso is losing value almost only against the US dollar. It is not because the peso is inherently weak. It is because, at the moment, the dollar’s value is influenced by hefty interest hikes imposed by American monetary authorities to stem inflation.

Against most other currencies, the peso’s exchange rate is constant – or even appreciating. All the world’s currencies are feeling the effect of US interest rate hikes. Higher interest rates attract conversions to the dollar, especially in the face of so much volatility in the global economy.

There is a way to get the peso to appreciate against the tide. This will require raising our own policy rates to match US rate adjustments – or attempt more hawkish rate hikes. But that could kill growth in our economy.

This week, the BSP increased policy rates by 25 basis points. That is considered a “dovish” response to the threat posed by inflation. It is substantially lower than the US rate increases. Our Monetary Board prefers to nurse economic growth.

Most academic economists are celebrating the erosion of the peso’s exchange value. They are going by the textbook argument that a cheaper currency will discourage imports, encourage exports and drive domestic economic activity.

In addition, the peso’s depreciation is supposed to boost the disposable income of households dependent on remittances from our large army of migrant workers. Domestic inflation, however, cancels out any palpable rise in the purchasing power of these households.

Many currencies – China, most notoriously – have been accused to driving up their exports by undervaluing their currency. The low exchange rate strategy made Chinese products comparatively cheaper. But recent increases in labor costs and disruptions in the supply chains have negated the advantages theoretically vested by lower exchange rates.

In our case, because the peso is losing value only against the dollar, the theoretical advantage to exports applies only to goods headed for the US market. This market has had a decreasing share of our trade. There are no export price advantages won for Philippine products headed to markets whose currencies remain at parity with our peso.

In addition, the Philippines, after many years of inward-looking protectionism, is not at all an exporting powerhouse. Our economic expansion is driven mainly by domestic consumption. Local products have high import content. This will reflect in rising prices for processed goods.

On the other end, there are those worried by the depreciation of the peso. The effects will be immediate and painful.

The worldwide surge in inflation is driven mainly by the sharp rise in oil prices. Our country imports nearly all our oil needs. The commodity is denominated in dollars, not in yen or yuan. Depreciation will magnify the cost of oil products for our consumers.

High oil prices affect everything our consumers pay for. They translate into higher electricity bills. Because most of our agricultural and fisheries products are transported overland, higher transport costs will impact on their final prices.

The depreciation of the peso will magnify the spike in inflation we are dealing with. This will translate into magnified pain for the poor.

We can only hope that presently pertaining exchange rate will not be permanent – although some economists see the peso’s present value as being in its “natural” level. About 17 years ago, the peso fell to about $1:P56. As markets corrected the peso rose to about $1:P50 and stayed at about that level for many years.

The peso could yet depreciate to that record low level – perhaps even exceed it by sliding to about $1:P57. This will depend on interest rate decisions made elsewhere and on the vagaries of market sentiment.

At this point, no one is willing to hazard a guess on where the peso will settle. There are simply too many moving parts in the system that dictates exchange values. There is a large amount of uncertainty prevailing over the global market. There are too many triggers for price and currency volatilities out there.

The peso is not the biggest loser against the dollar. The Japanese yen has that distinction. But no one can accuse either the Japanese economy or ours to be weak. Our economy is a growth leader in this region.

No one should even think about “controlling” the exchange rate. We are bound by international commitments to a free currency float determined by market forces. Besides, “controlling” the exchange rate will not only cost us dearly, it will produce adverse market speculation.

Recall how the Asian Financial Crisis happened. Thailand was evidently manipulating its exchange rate, as were other Southeast Asian economies. Market pressure built up and caused the currency to crash.

I remember then Central Bank governor Gabriel Singson constantly boasting during the late nineties how flat the exchange rate graph of the peso was. When the Asian Financial Crisis broke out, the peso crashed to nearly half its exchange value, forcing many of our companies into serious distress.

Let the peso find its value through the operation of market forces. Any other course will be unsustainable. Any attempt to intervene will be futile.