Why the USD-Php Remains a Buy: With No Major Source of Inflows, BSP FX Operations Buoyed the GIRs and Propelled the Peso Higher

The masses have never thirsted after truth. Whoever can supply them with illusions is easily their master; whoever attempts to destroy their illusions is always their victim—Gustave Le Bon

In this issue

Why the USD-Php Remains a Buy: With No Major Source of Inflows, BSP FX Operations Buoyed the GIRs and Propelled the Peso Higher

I. The BSP’s Push to Cover Economic and Financial Stress by Powering the Peso Higher!

II. USD Supply: No Major Source of Inflows from the Economic Backdrop

III. Increasing Risks of Inflation from Bailouts Financed by the Printing Press

IV. GIR’s Cosmetic Gains: The Use of Financial Derivatives Possibly Financed by the Banking System’s FX Deposits

V. As the World Goes MMT, Gold Should Rise Against Paper Money and the Peso!

Why the USD-Php Remains a Buy: With No Major Source of Inflows, BSP FX Operations Buoyed the GIRs and Propelled the Peso Higher

Has the peso transformed into a safe-haven currency?

Why has the peso outperformed its peers?

Has the peso been supported by fundamentals or the stock and flows of the USD?

This outlook shows how the BSP’s behind the scenes operations have influenced the vigor of the peso, mainly through the record-high GIR, and secondly, through market interventions.

The strength of the peso has been artificial and is likely to unravel as challenges to the economy are prolonged.

I. The BSP’s Push to Cover Economic and Financial Stress by Powering the Peso Higher!

Ever since the USD-PHP topped in the 4Q of 2018, its winning streak has continued. Since it peaked at 54.25 on September 26, 2018, the peso has returned 8.2%. Its .87% return in 2020 makes it one of the best-performing currencies in Asia.

The USD functioned as a traditional safe-haven when the Philippine economy suffered from a sharp slowdown or a recession or a crisis. (figure 1, table)

Figure 1

For instance, the USD-PHP zoomed for three successive years (30.13% in 1983, 50.27% in 1984 and 11.43% 1985) when the Philippines suffered an economic crisis following the declaration of the debt moratorium in 1983.

Nota Bene: The following USD-PHP quotes are based on the average annual USD-PHP as provided by the BSP.

Also, a year after the Asian Crisis surfaced in 1997, the USD-Php rallied by 38.8%. And as the economy healed from 2000 to 2001, the USD-Php firmed up by 13.06% and 15.38% significantly anew following a slight rebound in 1999.

The USD Php strengthened by 7.11% in 2009 as the economy nearly fell to a recession from the Great Financial Crisis.

The peso typically strengthens during the sweet spot of the economic growth.

But not today.

Despite the recent economic downturn/recession as a consequence of the political response to the COVID-19, the peso has remained ironically or contrastingly resilient.

The ECQ has added to the recent gains.

The peso rallied furiously, breaking below the 50-level when trading volume plummeted to multi-year lows as bank operations were less than half of its capacity during the ECQ. (figure 1, middle window)

Like the PSEi’s latest rebound, the strength of the peso emerged not only in the face of low volume but also because of the pullback of foreign participation. Foreigners were net sellers of Philippine assets in the first four months of 2020, according to the BSP’s Foreign Portfolio data. The four-month outflows reached USD 1.58 billion on the back of a 16% decline of USD volume.

The BSP chief has bragged they have been intervening to rein the strength of the peso.

From the Philstar (June 9): Diokno said the Philippines is well prepared in facing a crisis such as the coronavirus disease 2019 or COVID-19 pandemic compared to the Asian financial crisis in 1997 and 1998 as well as the global financial crisis in 2008 and 2009. “We are really in a very good shape, our reserve is at its highest at $90 billion in March and we feel it will be around $95 billion by the end of the year. Our banking industry is much, much stronger compared to where it was during the Asian financial crisis,” he said. The central bank usually participates in the foreign exchange market to soften the volatility of the local currency by dipping into its gross international reserves to buy or sell dollars. “We are already intervening. It could have gone much, much faster. It could have appreciated more if we did not participate in the market,” Diokno said. The BSP chief said there is a need to keep the peso competitive to support the export sector “I can tell you we are participating in the market,” he said.

My counterclaim is that instead of intervening to weaken the peso, the BSP has done the opposite.

By reducing foreign participation, organized local buying, most likely led by the BSP, constituted the demand side that propelled the peso to the upside.

II. USD Supply: No Major Source of Inflows from the Economic Backdrop

But the BSP has long been intervening to prop the peso up!

Figure 2

Domestic liabilities, such as deposits and currency issuances, are benchmarked to the international reserves, which account for 84% to 87% of the BSP’s assets. That is, the growth of the BSP's assets sets the limit to the growth of its liquidity. (figure 2, upmost pane)

Hence, for the BSP to remain in an expansionary mode, the amassment of FX assets have been a prerequisite. So as the BSP chopped bank reserves to reduce its share, the currency issuance share of total liability has been ramping up.

The BSP's GIR has been the fountainhead of the peso's strength. So they always say.

But that’s misleading. These represent instead post hoc rationalizations. Explosive growth in the foreign reserves of neighboring Thailand, Singapore and South Korea hasn’t prevented their respective currencies from weakening. As of June 12, the baht, SD, and won were down against the USD by 4.46%, 4.18, and 3.46% (year-to-date), correspondingly.

But importantly, has fundamentals or the supply side been supportive of this runup?

The supply of dollars that should make up the GIRs, from the economic operations, has been inadequate.

You read it from the news.

Expected to plunge are the dollar receipts from OFW remittances and tourism revenues.

From the Inquirer (June 5): The Philippines is seen as among the emerging markets to be hit by an up to 30-percent drop in remittances, based on the projection of Washington-based Institute of International Finance (IIF).

From the GMA (June 11): In a mobile message, BSP Governor Benjamin Diokno said tourism receipts are expected to contract by 56.9% this year, which could be the worst drop since the government started data collection on tourism receipts.

OFW remittances declined by 5% in March and have reinforced its long-term downtrend since 2014. (figure 2, middle window)

The Department of Tourism has not updated its visitor arrival statistics for 2020.

As stated above, foreign portfolio registered net outflows in the four months of 2020. Meanwhile, the growth dynamics of FDIs and services exports (BPOs) have continued to decline even before the emergence of COVID-19. The BSP’s FDI plummeted 32% last February, even before the ECQ, bolstering the downtrend since 2016. (figure 2, lowest pane)

From Philstar, June 11: Speaking of IT, while the outlook is bleak for remittances, the business process outsourcing (BPO) is likely to sustain its momentum. BSP sees BPO earnings growing 2% this year and 4% by 2021, although in absolute terms, dollars they funnel to the economy will remain below that of remittances at $22.8 billion by next year.

Even BPOs revenues have been in a decline.

Figure 3

And amidst the economic shutdown, a slight trade deficit (USD 500 million) still emerged as imports (-65%) and exports (-51%) collapsed in April. Trends that had been shaped in 2016-2017 have been cemented by the crash in merchandise trade last April.

These declines highlight the ongoing atrophy in the system even before the ECQ.

Again nowhere in the real economy has generated sufficient flows, so where has the BSP been getting its US dollars to prop up its GIRs?

III. Increasing Risks of Inflation from Bailouts Financed by the Printing Press

And here’s the thing. With deficit-to-GDP expected to hit 8.4% in 2020, aside from where will it come from, will there be sufficient supply from existing reserves to service domestic foreign exchange requirements (imports, debt servicing, financial trading, and others)?

And what about the money supply, which has recently spiked due to BSP monetization of the NG's fiscal deficit as the bank's economic loan portfolio slowed last March? 

M3 jumped from 10.9% in February to 13.34% in March.  Meanwhile, currency in circulation rocketed from 13.5% to 19.5%, possibly in preparation for the Php 200 billion cash transfer measure, the Social Amelioration Program (SAP), released last April. (Figure 3, middle pane)

The BSP has accounted for the most share of money supply growth, as the Total Loan Portfolio growth of the banking system decelerated from 10.96% to 7.86%. (Figure 3, lower pane)

From a different angle, so far, the BSP’s use of high-powered money through the direct financing of the record deficit, have offset the slowdown in credit expansion of the banking system, hence the tightening.

But what if sustained injections combust street inflation (and eventually the CPI)?

And with bailouts becoming entrenched as a popular fix to the economic quagmire, the use of the nuclear option policy of monetization of the deficits will likely escalate.

IV. GIR’s Cosmetic Gains: The Use of Financial Derivatives Possibly Financed by the Banking System’s FX Deposits

With a vastly reduced source of the USD from the economy, how has the BSP been able to spruce up the peso?

The short answer: derivatives.

Figure 4

Through 2019, the IMF’s data shows that the organic component of BSP’s GIRs has barely grown.

Ever since the USD-Php peaked in the 4Q of 2018, a buildup of “other foreign reserve assets” comprised the BSP’s GIRs through 2019, as shown by the IMF’s International Reserve and Foreign Currency Liquidity (IRFCL) data. (Figure 4, highest window)

“Other foreign reserve assets”, according to the IMF, constitute the marked-to-market value of financial derivatives, short-term foreign currency loans, other financial assets (such as non-negotiable investment funds shares/units arising from pooled asset schemes) and repo assets.

Furthermore, the growth of FX deposits in the banking system has not only been in a downtrend but has recently suffered contraction (last November and December), which comes as the GIRs reached a record. (Figure 4, middle pane)

Have FX deposits of the banking system been diverted to the propping up of the BSP’s GIRs?

And related to this, Philippine financial system interactions with the US banking system have surged since 4Q 2018, as shown by the spike in % growth of US banking claims on the Philippines. The same holds true for US banking liabilities to the Philippines. (Figure 4, lowest panes)

I dealt with this last January*.

*Record GIRs Amidst Deflation in the Banking System FX Deposits, Booming Crossborder Credit Transactions and Derivatives! January 20, 2020

Have the FX deposits of the banking system been diverted or used to fund a massive dollar short position via financial derivative trades (FX swaps, repos, and other instruments) to prop up the GIRs as exhibited by the IMF’s IRFCL data?

To simplify, the record-shuttering streak of the GIR appears to have emanated from the BSP’s stealth FX operations, as well as, partly from official external borrowings.

What will be the costs of taking on these dollar short positions? And how long can the BSP’s operation mask the looming shortages of in the supply of the domestic USD?

Yes, Japan’s credit rating agency, the JCR, upgraded the credit profile of the Philippines last week, but rather than the understanding of how GIRs work, this upgrade was based on statistics and hope.

Once the BSP’s cosmetic procedures unravel, we can expect these credit rating agencies to adjust swiftly.

In this perspective, the USD PHP remains a buy.

V. As the World Goes MMT, Gold Should Rise Against Paper Money and the Peso!

Finally, the valuation of a monetary unit, wrote the great Ludwig von Mises, depends on the relationship between the quantity of, and demand for, money.

Figure 5

The US M2 rocketed 23.22% last June 1 as the Fed increased its balance sheet by the $3.01 trillion in about three months, the fastest expansion in history, and as the Trump administration unveiled a USD 2 trillion fiscal bailout program last March. (Figure 5)

Because of this bailout, US deficits nearly doubled last May, while total domestic nonfinancial debt jumped by 11.7% to $55.9 trillion. (Figure 5)

The peso would seem to benefit from the recent developments in the US, but the US has a unique advantage, its role as the primary foreign exchange reserve under the de facto US dollar standard.  

Furthermore, everything is in a state of flux. With over 80% of countries in the world about to endure a recession, an unparalleled event since 1871(Figure 5, lowest pane right), and one can expect similar central bank financed bailouts implemented in these affected nations. As such, the use of the central bank’s nuclear option will not only be a feature; it will be on a historic scale.

It will be a race to the bottom for fiat currencies.

And the gold’s ascent against the paper money system (including the PHP) can be expected to accelerate. (Figure 5, lowest pane left)