Brexit, weaker yuan to weigh local currency
External volatility related to Brexit and the weak Chinese yuan will weigh on the Philippine peso and likely pull the local currency lower through the end of this year into 2017, Fitch-owned BMI Research said.
In a report, BMI downgraded its end-2016 forecast for the peso to P49 to $1 from P47 to $1 previously, reflecting expectations for the currency to experience additional depreciation over the next three to six months.
Its 2017 forecast was also downgraded to P48.50 to $1 from P46.50 to $1 previously.
“The Philippine peso has come under pressure from the UK’s shock decision to leave the EU on June 24, and we believe that the currency will experience continued volatility over the near-term,” it said.
BMI said the fall-out from the UK’s decision to leave the EU is still being felt, and the peso will be subject to considerable volatility over the near-term as markets continue to digest the news.
Nevertheless, weakness will be limited by the currency’s strong structural position, it noted, and it does not see that the Brexit decision will have considerable bearing on the Philippines or, indeed, the broader Asian region over the medium-term.
“If anything, the UK is likely to look to deepen trade linkages with the region as it begins to rationalize its position outside of the economic bloc, and this should present new opportunities for the Philippines and its regional peers,” it said.
But one significant second-round effect to be considered following Brexit is the decision’s impact on the US Federal Reserve’s interest rate policy, it added.
BMI said the destabilizing nature of the shock decision has likely ruled out any further hikes from the Fed for the remainder of 2016, and when the dust settles, this will mean that the Philippines’ real interest rate differential will remain intact.
“While we do not expect this to be a significantly appreciatory factor for the peso, it does remove a key risk to our previous forecast, as a more aggressive-than-expected normalization campaign by the Fed would most likely have sent the peso lower against the US dollar,” it said.
Meanwhile, BMI said expectations for the Chinese yuan to depreciate to CNY6.80 to $1 and CNY7.10 to $1 by the end of 2016 and 2017, respectively, would act as a drag on the Philippine peso.
While it expects the CNY to underperform its regional peers, it will still have a depreciatory impact on regional currencies, it said.
BMI noted that the peso is also strong from a real effective exchange rate (REER) perspective, and believes that the central bank has assumed a slightly depreciatory strategy with regards to the currency in order to restore competitiveness.
“Considering the fact that China is a major trade partner of the Philippines (even more so when accounting for the fact that many shipments to Hong Kong are likely bound for the mainland), the Bangko Sentral ng Pilipinas (BSP) will be keen to avoid significant appreciation of the peso versus the yuan, strengthening the feedback mechanism between the yuan and the peso,” it said.
Over the long-term, BMI believes that the peso’s strong fundamentals should help to reinstate a gradual appreciatory bias in the currency.
It noted that the peso has plenty in its favor from a structural perspective such as strong real gross domestic product growth; a consistent external surplus powered by strong net foreign direct investment and remittances; and a manageable rate of inflation.
However, BMI said these strengths would be countered in the medium-term by difficult external and technical conditions.
For this reason, BMI said it is adopting a roughly neutral outlook on the currency for 2017.
BMI said risks to its outlook are largely balanced, noting on one hand that markets are now pricing in a slightly larger probability of a rate cut by the Fed at its next meeting.
“If this were to come to fruition (well outside of our core view for a hold for the remainder of the year), the peso would likely outperform our forecast,” it said.
On the other hand, BMI believes that the Chinese yuan is still far from fair value, and that pressures are stacked against it.
“Should the CNY experience a more acute depreciation than we are forecasting, this would almost certainly take the peso weaker than our expectations for the currency,” it said.