Friday, April 08, 2011

Questions and Answers on Philippine Monetary and Fiscal Issues

The following is my to answer some of the questions that my colleagues have posted on facebook group which they say is required for their research.

Role of Central Bank and Currency Interventions

With reference to the record $66.2 billion Gross International Reserves (GIR) the Philippines has tallied for the first quarter of 2011, this can be broken down into Foreign Investments, Gold, Special Drawing Rights (SDRs), foreign exchange and Reserve position in the fund.


Breakdown of Gross International Reserves (Bangko Sentral ng Pilipinas)

Reserve assets can further be broken down into securities mostly in foreign bonds and notes and secondly in foreign currency cash and deposits.


Reserve asset breakdown Bangko Sentral ng Pilipinas

The role of the BSP, like all other central banks, is to manage exchange rate fluctuation and or the state of balance of payments.

They do this by either indirect foreign currency intervention (tweaking money supply) or indirect foreign currency intervention (buy or sell foreign currencies with local currency) [Steven M. Suravonic, International Finance Theory and Policy]

And in managing capital inflows they can be sterilized or non-sterilized. Non sterilized intervention can result to inflation.

Jang-Yung Lee explains [IMF 1997 Sterilizing Capital Inflows]

Capital inflows result in a buildup of foreign exchange reserves. As these reserves are used to buy domestic currency, the domestic monetary base expands without a corresponding increase in production: too much money begins to chase too few goods and services.

To ease the threat of currency appreciation or inflation, central banks often attempt what is known as the "sterilization" of capital flows. In a successful sterilization operation, the domestic component of the monetary base (bank reserves plus currency) is reduced to offset the reserve inflow, at least temporarily. In theory, this can be achieved in several ways, such as by encouraging private investment overseas, or allowing foreigners to borrow from the local market. The classical form of sterilization, however, has been through the use of open market operations, that is, selling Treasury bills and other instruments to reduce the domestic component of the monetary base. The problem is that, in practice, such sterilization can be difficult to execute and sometimes even self-defeating, as an apparently successful operation may raise domestic interest rates and stimulate even greater capital inflows. Unfortunately, many developing countries also lack the tools available to run a classical sterilization policy, or find it simply too costly to do so. This is often the case wherever the financial system is not fully liberalized.

The Philippines has undertaken both measures with questionable results.

From the ADB Institute,

As described earlier, the BSP has engaged in both sterilized and unsterilized intervention. A simple correlation analysis indicates that intervention, as measured by the percentage of international reserves, has limited impact on the exchange rate’s level, percentage change, and volatility (Table 11 [ PDF 53.5KB | 1 page ]).10 The results indicate that intervention had a modicum of success in reducing exchange rate volatility in the Philippines between 1993 and 1996. Meanwhile, intervention prevented a rise in the exchange rate (measured in US$/peso) after the crisis, particularly during the period 2003–2007. In many instances the results are counter-intuitive, i.e. the correlation coefficient is positive, similar to the result of the impulse response function that was presented in Section III (Figure 4 [ PDF 42.8KB | 1 page ]). ADB Institute, Evaluation of Policy Responses, March 5, 2008

External Debt (Fiscal and Monetary Issues)

The question of debt has also been raised.

External debt as defined by the BSP covers all short-term and medium-term obligations of the BSP, commercial banks, public and private sectors payable to non-residents.

One must be reminded that external debt which covers by the national government is a fiscal issue whose repayment is allocated by the Philippine Congress. The 2011 php 1.645 trillion budget allocates 23% to debt servicing (dateline Philippines, President Aquino’s Budget message—Office of the President’s Official Gazette)

The BSP’s role according to Manila Bulletin/Cuervo Far East is to set “internal annual debt ceiling to monitor foreign borrowings, either from commercial sources or from official development assistance funds or donor aids.”

External Objectives and the Role of Forex Currency Reserves

Now domestic monetary policy is about domestic political and economic issues, and is hardly about coordinating inflation with external sources.

External issues are assumed by currencies that play the role of foreign currency reserves, where the conflict of interest between domestic and international objectives engenders what is known as the Triffin Dilemma.

IMF During the 1997 Asian Crisis and the Philippine Debt Moratorium in 1970-80s

During the Asian crisis the left has blamed liberalization, pegged currency and high interest rates (Walden Bello) when the problem has been a global rotational issue of bubble cycles.

Paper money has never been about sound money. It has been about political objectives.

As to whether the restricting Peso ‘inflation’ would hurt the US dollar hegemony, US dollar’s hegemony depends largely on the sustainment of its inflationist policies. If the US recklessly pursues a dollar debasement as their main policy thrust, countries will either jointly devalue (race to the bottom or competitive devaluation) or abandon the US dollar as a foreign currency reserve.

Finally, with regards to the role played by the IMF during the Philippines during the Philippine debt moratorium

Country-data com provides some clue: (bold emphasis mine)

On October 17, 1983, it was announced that the Philippines was unable to meet debt-service obligations on its foreign-currency debt of US$24.4 billion and was asking for a ninety-day moratorium on its payments. Subsequent requests were made for moratorium extensions. The action was the climax of an increasingly difficult balance of payments situation. Philippine development during the decade of the 1970s had been facilitated by extensive borrowing on the international capital market. Between 1973 and 1982, the country's indebtedness increased an average of 27 percent per year. Although government-to-government loans and loans from multilateral institutions such as the World Bank and Asian Development Bank were granted at lower-than-market rates of interest, the debt-service charges on those and commercial loans continued to mount. In 1982 payments were US$3.5 billion, approximately the level of foreign borrowing that year and greater than the country's total debt in 1970. The next year, 1983, interest payments exceeded the net inflow of capital by about US$1.85 billion. In combination with the downturn in the world economy, increasing interest rates, a domestic financial scandal that occurred when a businessman fled the country with debts estimated at P700 million, escalating unrest at the excesses of the Marcos regime, and the political crisis that followed the Aquino assassination, the debt burden became unsustainable (see table 16, Appendix).

The Philippines had turned to the IMF previously in 1962 and 1970 when it had run into balance of payments difficulties. It did so again in late 1982. An agreement was reached in February 1983 for an emergency loan, followed by other loans from the World Bank and transnational commercial banks. Negotiations began again almost immediately after the moratorium declaration between Philippine monetary officials and the IMF. The situation became complicated when it came to light that the Philippines had understated its debt by some US$7 billion to US$8 billion, overstated its foreign-exchange reserves by approximately US$1 billion, and contravened its February 1983 agreement with the IMF by allowing a rapid increase in the money supply. A new standby arrangement was finally reached with the IMF in December 1984, more than a year after the declaration of the moratorium. In the meantime, additional external funds became nearly impossible to obtain.

In each of these arrangements with the IMF, the Philippines agreed to certain conditions to obtain additional funding, generally including devaluation of the peso, liberalization of import restraints, and tightening of domestic credit (limiting the growth of the money supply and raising interest rates). The adjustment measures demanded by the IMF in the December 1984 agreement were harsh, and the economy reacted severely. Because of its financial straits, however, the government saw no option but to comply. Balance of payments targets were met for the following year, and the current account turned positive in FY (fiscal year--see Glossary) 1986, the first time in more than a decade. But there was a cost; interest rates rose to as high as 40 percent, and real GNP declined 11 percent over 1984 and 1985. The dire economic situation contributed to Aquino's victory in the February 1986 presidential election.

Hope this helps,


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