What is happening to the peso?

Last week, the Philippine peso plunged to a new low.  Depending on what business paper you read, it was a six month low for the Business Mirror and a nine month low in BusinessWorld. The Philippine Star had it also at a nine month low. The peso has recovered somewhat towards weekend but the direction seems to have a Southward bias. Whatever it is, the decline has caused concern for some people and joy for others.

Some readers have e-mailed me asking what I thought of the peso’s plunge and if I can offer a projection at least for the year-end. If there is one lesson from the late Ka Doroy Valencia I have taken to heart, it is to never make a prediction unless I am sure the event has happened. So, I will not offer a guess. But I will try to examine the various factors that impacts on the exchange rate.

The basic thing to remember about currency exchange rates is that these are essentially a matter of demand and supply. If there is more demand for pesos because people with dollars are eager to exchange their dollars for pesos, the peso becomes more expensive or stronger. If there are more people dumping their pesos and buying dollars, the reverse happens.

The supply of dollars in our economy is affected by such things as our earnings from exports and to a lesser extent, from tourism. Dollars coming into our economy from investors is another source. Proceeds of foreign borrowings of government and private sector entities are still another source of dollars.

In good times when we have a lot of export proceeds from such industries as semiconductors and bananas, coupled with a steady flow of portfolio investment dollars into our stock market and heavy OFW remittances, the peso becomes strong. That’s because these entities stir strong demand for the peso as they convert their dollars to our local currency.

What we have today is weak export earnings. Based on the last GDP report, exports fell even more steeply than before (-16 percent, a steeper drop than the previous quarters’ -11.5 and -14.7 percent). Investment spending also continued to shrink (-9.8 percent). So that even if OFW remittances can still be considered strong, the peso is under siege. The rising cost of oil and petroleum products, almost all which we import and thus pay for in dollars also put pressure on the peso. This explains why it hit a low of 49.01 to the US dollar last week.

A local analyst from the Rizal Commercial Banking Corp. was quoted by the local business press saying he expects the peso to consolidate at between 48.50 and 49, and that “a test of the 49 level is expected as dollar inflows from remittances dry up and the import season starts.”

We have just entered the “ber” months and as Christmas carols starting airing in the shopping malls, importers of Christmas goodies will be demanding a lot of dollars to cover their advance purchases. This is also the time our OFWs start saving their money so they can send back something substantial for Christmas.

But what really triggered the sharp drop of the peso are revived uncertainties about the recovery of the US economy. There were new worries about the health of US banks which prompted investors to become more risk-averse. This mindset makes them sell “riskier” assets in their portfolios such as those in emerging market economies. This does not seem to make sense given that emerging economies appear to be recovering ahead of the Western economies and also offer better returns, but it happens anyway.

Over the past few weeks, it did not help that the Shanghai market also took a sharp downturn so that the negative sentiment affected us too. Thus, there are traders and analysts who think the biggest drag on the peso over the past week were external factors.

The peso will continue to be sensitive to developments in the global market, according to analysts and economists at First Metro Investment Corp. (FMIC) and University of Asia and the Pacific. In their joint monthly commentary published by FMIC, the investment banking arm of the Metrobank Group, the economists said the dollar may strengthen further as other economic indicators point opposite to the sought-for recovery. American unemployment figures, for instance, remain unnervingly high.

The economists are referring to the rise in the greenback against the major currencies on Tuesday last week following a sell off in equities on Wall Street. The so called green shoots of economic recovery may not be robust enough for comfort. They are starting to realize that economic recovery will be slow and painful.

That affects the peso exchange rate too as investors retreat to the safety of the dollar. “The peso-dollar rate is likely to have a depreciation bias for the rest of the year, with some respite in November-December,” they said in the August issue of FMIC-UA&P’s monthly publication The Market Call.

Our only big hope for the peso rests on OFW remittances which normally pick up in the last two months of the year. This provides a boost to the peso especially during the Christmas holidays.

But there are a few other factors that also affect the peso’s value and these are internal to us. One has to do with our fiscal deficit expectation and the other is the political risk factor related to the outcome of next year’s elections and the peaceful transition to a new administration. Any credible threat of a “coup” or some other form of extra constitutional transfer of power will sink the peso’s exchange rate too.

A news dispatch of Dow Jones from Singapore cited “growing concern over the Philippines’ widening budget deficit may weaken the peso, sending the dollar back above P50 later this year, analysts say.” The same dispatch noted that “the Philippine economy remains in the doldrums even as other Asian countries start to recover from a deep downturn, crimping tax revenue. While many Asian currencies have rallied against the dollar, the peso has foundered.”

Dow Jones isn’t very hopeful we will be able to remedy the situation. “Dwindling tax and customs revenue will likely make it difficult for Manila to implement a stimulus package worth almost 5 percent of domestic product approved for this year, without breaching its deficit target. This is a worry in a country that has in the past been notorious for budget overruns, which have resulted in financial and even political instability.”

Of course our government says it still expects to keep the annual deficit below the target, but analysts say its revenue assumptions for the second half are likely to prove optimistic. “Higher deficits now imply an increase in the debt load and may force the next government to raise taxes or cut spending dramatically after next year’s presidential election. Both would hurt future economic growth.”

The Royal Bank of Scotland said “while expenditures are sharply on the rise to support growth, fiscal deterioration is also being pushed by revenue collections heading the other direction.” RBS forecasts the full-year deficit will hit 4.3 percent of GDP. It expects the dollar will rise to P51 by September and P52 by June, soon after the elections scheduled for May.

RBS analysts expect asset sales (through privatization of state-owned companies) and Congress to pass revenue measures in the second half, both of which in our view are unlikely given the economic environment and the elections next year. Our economy, while vastly improved over the last decade, pales in comparison to those some of the Philippines’ neighbors.

So… there… –Bii Chanco (The Philippine Star)