The Tremendous Cost of Supporting the Peso: Short-Term Gain, Long-Term Pain

In this issue

The Tremendous Cost of Supporting the Peso: Short-Term Gain, Long-Term Pain

-One Voice, One Theme

-A ‘Bold’ Mainstream Prediction?

-Propping the Peso Through USD Borrowing and USD Asset Liquidations

-The Peso as the Sacrificial Lamb in the Altar of Political Convenience

The Tremendous Cost of Supporting the Peso: Short-Term Gain, Long-Term Pain

One Voice, One Theme

The DBCC typically publicizes the government’s projections of the USD peso exchange rate.

The Development Budget and Coordinating Committee (DBCC) represent a composite body of four member agencies; namely, the Department of Budget (DBM), the Department of Finance (DoF), the National Economic and Development Authority (NEDA) and the Presidential Oversight (OP) and in 1998, the BSP became part of the body as a resource institution. The DBCC’s role is to “review and approve the macroeconomic targets, revenue projections, borrowing level, aggregate budge level and expenditure priorities and recommend to the Cabinet and the President of the consolidated public sector financial position and the national government fiscal program”

Here is the track record of their forecasts.

Philstar, November 6, 2013: “The government expects the peso to average between 41 and 43 per dollar this year, a revision from an earlier range of 42 to 45 to a dollar. Guinigundo noted that the inter-agency Development Budget Coordination Committee (DBCC) may revise assumptions anew before the end of the year.”

In 2013, the USD Peso closed at Php 44.395.

The Manila Times June 24, 2014: “Explaining the assumptions for the revised forecast of P42 to P45 to $1 for 2014, against a previous projection of P41 to P44, Bangko Sentral ng Pilipinas (BSP) Deputy Governor Diwa Guinigundo said the new range came as a result of an assessment of global factors by the inter-agency Development and Budget Coordinating Committee (DBCC).”

The year 2014 ended with the USD Php at 44.72.

The Manila Times, April 8, 2015: “The DBCC also adjusted its peso assumptions for the year. It now sees the local currency ranging between P43 and P46 to the dollar from its previous forecast of P42 to P45.

The USD Php closed the year of 2015 at 47.06.

The Manila Standard, February 15, 2016: “The exchange rate target for 2016 to 2018 was also revised from a range of P43 to P46 per US dollar to a band of P45 to P48 a dollar.”

2016 ended with US Php at 49.72.

MarketMonitor.com, December 25, 2016: Budget Secretary Benjamin Diokno, after a meeting of the inter-agency Development Budget Coordination Committee (DBCC), said the committee has revised the 2017-18 foreign exchange assumption to 48-50from 45-48 in the earlier projection for 2016-18.

The end of the year 2017 quote of the USD Php was at Php 49.93.

Inquirer.net April 23, 2018: “As the Cabinet-level Development Budget Coordination Committee meets on Tuesday, economic managers are expected to approve the DBCC executive technical board’s new foreign exchange projection of 50-53:$1 for 2018, while keeping the 49-52:$1 range for 2019-2022.

These represent the official forecasts of the combined agencies. Despite the constant revisions to adjust with market prices, the government has an unimpressive 40% batting average.

Naturally, internal projections, like from the BSP, would remain classified.

Importantly, the DBCC’s projections serve as a cornerstone to the forecasts of establishment institutions. 

A paramount consideration of the banking institutions will always be the interests of its regulators. That’s because to go against their agenda would be very costly. The government can cut off business transactions with them. Or, regulators can breathe down the necks of any headstrong institutions thereby choking them with bureaucratic, if not other political hurdles.

The JP Morgan’s experience of downgrading Indonesian stocks in January 2017 should serve as a noteworthy example. The Indonesian government retaliated by banning JP Morgan from doing business with them, prompting the latter to reverse course swiftly.

This episode reveals why economic and financial communique of establishment financial institutions seems to speak in a single voice and talk with a unified theme.

And any deviations from the establishment lines must always cater to external influences.

A ‘Bold’ Mainstream Prediction?

On this note, here is a “bold” outlier projection dished out by an institutional expert who sees the USD Php at 54-55, quite a distance from the DBCC’s projections.  

From the Inquirer.net (July 13, 2018): “The peso may weaken to 55 against the US dollar this year as foreign capital flows out of emerging markets into developed markets, the treasurer of China Bank said. “We will probably revisit new (dollar) highs…emerging markets are flopping,” China Bank treasurer Benedict Lee Chan told reporters yesterday.  “You’ve seen the United States raise rates. You’ve seen ECB (European Central Bank) and the rest of the G10 countries also raising rates. With that, capital flows are going out of the Philippines,” he added. As such, he said the peso could test 54-55 levels against the dollar this year…Chan is also expecting the inflation-targeting Bangko Sentral ng Pilipinas (BSP) to raise interest rates two more times for the rest of the year, the first 25 basis points of which would likely come in August. But the August monetary setting will also depend on how inflation will fare this July. This means that the rate hike may be more than 25 basis points if the inflation rate continued to overshoot expectations…“Hopefully everything subsides, so we can come back down to around 53,” Chan said.

The article makes it appear that the peso is so helpless against external forces. If so, why does the BSP exist?

And under the given scenario the peso is presumed as being pegged or fixed with US dollar. And yet, under the given scenario, if the BSP truly wants to stabilize the peso, what it can do is to preempt the major central banks by aggressively boosting rates.

However, the question is; can it afford to do so? Can the BSP raise funding costs steeply that could risk strangling, not only the bubble industries but also the National Government’s aggressive public spending????

Of course, the terse answer is NO, because this would send the debt-dependent economy into a tailspin!

Recall that in the 1Q 2018, PSE 30 firms borrowed Php 518 billion to generate a puny Php 10.832 billion in net income growth. As interest rate rise, just how sustainable can such deluge of borrowing be? 

Yet, I can’t blame these experts; they are paid to say such blarneys. I would perhaps do the same when in their shoes.

Propping the Peso Through USD Borrowing and USD Asset Liquidations

Recent data shows that the National Government has been borrowing foreign exchange massively to contain the fall of the peso.

Figure 1

The Bureau of Treasury (BoTr) registered a 9.08% increase in foreign exchange borrowing last May. Factoring in the USD-Php appreciation, net borrowing of foreign denominated loans grew by 3.47%.

Aside from borrowing, the National Government appears to be rapidly liquidating its USD holdings.

Philippine government’s holdings of US Treasury securities continue to shrink. US Treasury data shows of a 17.23% crash in UST holdings of the Philippines to $31.5 billion last April.

Figure 2

And it is interesting to note that external trade continues to deteriorate. While imports grew by 11.38% in May, exports shrank by -3.8% for the fifth consecutive month of contraction.

Have we been told that a weak peso would boost exports?

And because imports grew while exports shrank, trade deficit ballooned to $3.7 billion in May.

And because of the gaping trade deficit, May current account deficit swelled to $ 2.08 billion, the largest since 2014.

To finance these gaps would require USD flows. And this may be one of the reasons for the NG’s external borrowings.

Figure 3

And as you have probably read, Gross International Reserves plummeted to $77.68 billion, a 6-year low in June as the BSP’s liquidations of foreign assets continue. Still, the BSP attempts to reduce the damage on the data by increasing its record forex position (which could be about derivatives)

So to control the USD Php from an accelerated ascent, the National Government has borrowed foreign exchange to supply domestic foreign exchange requirements which had been helped by the sharp liquidations of the BSP of its foreign investment holdings.

And external or USD borrowings translate ‘short’ positions. 

 

Figure 4

The BSP’s dollar woes have become evident even in its balance sheet where the growth of international reserves has been stagnating while bank reserves growth has substituted for its decline (as of April).

With the stock of the peso reserves growing faster than the USD assets, this shows why the peso has been weakening.

The Peso as the Sacrificial Lamb in the Altar of Political Convenience

While it may be true that external forces may influence the price dynamic of the USD-Php, the peso’s health will ultimately depend on the robustness of its immune system.

In that respect, the peso fails. The BSP’s continued reliance on boosting money supply through credit inflation and through unconventional means to fuel an artificial boom is by no means a cost-free action. Aside from the peso, such redistributive policies have begun to take an enormous toll on the political economy.

In a not so distant future, phony booms would morph into a harrowing bust. To paraphrase Warren Buffett, once the tide recedes we shall discover who has been swimming naked.

And as I have long been saying here, the peso has signified as the convenient sacrificial lamb in the altar of political expediency.

And it has been so!

For now, once the BSP eases on supporting the peso directly or indirectly, its fall will likely accelerate.

Buy the USD-Php!