currency appreciation

At last, some sen$e!

Monetary officials have finally learnt how to deal with the rising peso–something I have been advocating they do since late last year.

When I flagged the problem of an appreciating peso back in November 2010 (see What Should be Done About the Rising Peso?) and suggested some ideas on how to remedy the situation (setting up a sovereign wealth fund), I was met with more than a little bit of skepticism by readers. At that time, our foreign reserves climbed to $44 billion from $33 billion a mere eighteen months earlier.

In January this year, I pointed out the strategies of similarly situated Latin American central banks and finance ministries (see What Should be Done with a $14.4 billion BoP Surplus?). My advocacy for us to turn to methods outside the traditional toolkit of monetary policy seemed far-fetched as Bangko Sentral officials then were expressing satisfaction with the effectiveness of their interventions in the currency market. Again, my ideas were met with a bit of scorn by some readers.

And then in July this year, when our gross international reserves for the first time exceeded our external debt obligations, I made the following policy pitch in Crediting the Upgrade:

To prevent the peso from rising, what the government could do is coordinate with the BSP so that it could issue treasury notes and have the BSP purchase them (much in the same way the US Federal Reserve bought US treasury securities under Bernanke). This would lower the borrowing cost of the government given the BSP’s views that the country is actually of investment grade.

The proceeds of this could either go to funding the fiscal deficit, or as we reach a balanced budget over the next two to three years be used to set up two funds. The first could be called the Philippine Enterprise Innovation Fund or PEIF. The second could be called the Regional Philippine Infrastructure Fund or RPIF.

I had honed the idea from suggesting a sovereign wealth fund that would look at investment opportunities both domestic and overseas to more inward directed investment opportunities. The channel through which the fund would be created was to be through the BSP purchasing sovereign debt issued by the National Government (in effect becoming a creditor of the government). This would reduce our need to borrow from abroad, which would lower the pressure on the peso to appreciate.

With this last pitch, I thought I had a winner, although not much in terms of reader response occurred. Also, as the storm clouds seemed to gather on the horizon, I found the BSP’s response to be similar to the government’s–a wait and see strategy, which I felt needed to be more pro-active (see Bullet-proofing the Economy and A Full-Blown Economic Storm). The government was still banking on its credit upgrade and private partnerships to save the day.

The policy space just seemed sterile with worn out mantras and textbook formulas. Then today, I gained some level of comfort in discovering that our officials might have finally “seen the light” by reading Benjamin Diokno’s column. In it, he describes the offer made by Bangko Sentral Governor Armando Tetangco to loan the government dollars and be repaid in pesos as a “Win-win Move“!

What might have tipped the conservative monetary authorities over was the Philippines attaining its full-year gross reserves target of $75 billion in the middle of the year. Diokno highlights the precariousness of maintaining current fiscal and monetary policies by saying,

(F)or every peso appreciation, BSP stands to lose P75 billion. Isn’t that awful? Hence, Mr. Tetangco is not offering the government out of the goodness of his heart; he’s doing it because it’s the prudential thing to do. It’s a win-win solution to our economic woes: it helps BSP in its war against peso appreciation and, at the same time, it helps the government pay for its foreign debt without incurring serious foreign exchange risks….

In hindsight, it was not even necessary for the Philippine government to borrow from the World Bank and the Asian Development Bank to finance its conditional cash transfer (CCT) program. Floating five-year Treasury bonds would have been a better way of financing the program.

At last, even traditional economists are beginning to realize what a golden opportunity the Philippines was sitting on! Ah, yes! There are times when it just feels good to be right. And this is definitely one of them. Let us hope our finance officials are able to learn the “policy catch-up” game just as our monetary officials have finally learned to. It’s about time they gained some sense.

…And PIIGS might fly

The following is an interesting chart that shows the projected debt positions of the various PIIGS economies (PIIGS stands for Portugal, Ireland, Italy, Greece and Spain), the US and other economies with triple AAA credit ratings or near investment grade ratings.

It demonstrates why these economies are in such dire straits at the moment. The debts of Greece are the highest at 1.5 times the economy (Greek tragedy). Ireland is next at 1.2 times (the luck of the Irish) and Italy is third at 1.15 times (Italian job).

The US which has been downgraded for the first time in eighty years is projected to breach the 100% debt to GDP ratio after this year given the tepid pace of its economy and expanding entitlement system. Spain has debts at a mere 64% of its economy but is expecting to see them rise on an upward trajectory to 75% by 2016.

Other triple A rated economies either have low debt to GDP levels (Austria, Australia, Denmark and Finland) or are on a downward path to sustainability (France, Germany, Singapore and the UK).

The Philippines and Indonesia which are both one notch below investment grade do not seem to share the problems of the PIIGS with moderate (Philippines) to low (Indonesia) levels of debt and they are both expected to decline over the next few years. The yield of their bonds are trading lower than the Portugal, Ireland or Greece (translation: creditors have greater faith in their ability to repay their debts than the P-I-G economies).

The Philippines stood at the precipice of a sovereign debt crisis back in the last decade with debts rising from 60% to above-70% between 2000 and 2003, but pulled itself back with a combination of increased taxes, fiscal consolidation and a currency appreciation with debts returning to a more manageable level of below-50% in 2007 right before the Global Financial Crisis broke.

The structural adjustment that occurred after 2004 allowed the country to weather the GFC from 2008 to 2010 relatively unscathed. Now that the new government has continued the cautious fiscal consolidation of its predecessor, the question is whether growth will be as robust as it was from 2007 to 2010.

Some might say the fiscal contraction that took place in Q4 of 2010 and Q1 of 2011 will provide the necessary cushion for the government now. The problem is with the slowdown of GDP that the country has experienced this year and into the next few, revenues might not scale up as they were originally projected leaving it with limited options now that fiscal stimulus has gone out of fashion.

Indeed, fiscal contraction has its merits, but it also has its drawbacks when used excessively. Can a country engage in it indefinitely and expect an economic takeoff? Yes, sure it can…and pigs might fly.