THE peso has been outperforming the rest of its regional peers, but the Philippine currency is unlikely to be spared from volatilities once the United States Federal Reserve starts to crank up on policy rates, analysts from the Bank of the Philippine Islands (BPI) said on Thursday.
“The local currency has outperformed most of its peers on the back of its healthy reserves and chronic current account surpluses,” BPI noted in its “Global Markets” report.
Year-to-date, the peso depreciated by only 0.8 percent as compared to the steeper falls by other emerging market (EM) currencies.
One reason for the currency’s performance on the spot market is the adequate coverage in terms of the foreign exchange reserves-to-external debt ratio. This underpins the Philippines as one of the least vulnerable in the EM space.
However, BPI emphasized that the peso’s relative strength may wane once the Fed decides to increase the policy rates.
After almost six and half years of near zero rates, the Fed is expected to make the move on interest rates in the second half of 2015. Fed funds futures show a likely increase of 50 bps (basis points) in 2016 and another 50 bps by mid-2017, it said.
The bank warned that volatilities in financial markets cannot be avoided and will inevitably impact emerging markets as funds shift back to the United States for better yields.
“Despite the improved fundamentals and the stamp of assurance from credit rating agencies, contagion among emerging market economies will ensue and the Philippine peso will possibly be dragged along with the rest of the region and asset class,” it said.
By association, the peso will take on the headwinds as long as it takes for other EMs even in distant places like Brazil, Turkey, South Africa can affect the Philippines to weather the situation.
Despite the foreign reserves-to-debt coverage, and foreign exchange receipts from services and primary income are significant versus its peers, the size of unhedged or currency mismatched borrowings could trigger pressure in the foreign exchange market if another “tantrum” episode hits emerging markets.
“The peso may face headwinds given the increased external leverage corporates have accumulated in the recent past,” the report read.
BPI pointed out the total external obligations of the Philippines is nearly 2.5 times bigger than its core exports. The Philippines not only tops the list in this measure, its leverage multiple is significantly higher than the norm of 1.5 times.
This means that compared to the region, the country has the biggest unhedged exposure relative to the size of the entire foreign exchange liabilities of the economy – both hedged and unhedged.
“To avoid a significant erosion of their net worth, these unhedged borrowers will likely be the top buyers of US dollars when the greenback starts rallying versus most other currencies as the FOMC [Federal Open Market Committee] begins its series of rate hikes,” the report noted.
Still, the steady flow of remittances and the central bank’s foreign exchange reserve buffer may temper the depreciation but probably not enough to avoid an uptick of dollar-peso rate due to lumpy demand from the unhedged borrowers, BPI said.
This reaction may spark pressures on the peso, pushing it toward a more competitive position somewhere in the middle of the Association of Southeast Asian Nations (Asean) pack – and no longer a front-runner in the EM space.
There is, however, a need to maintain competitive stance within Asean as exports and business process outsourcing (BPO) have become more integral to Philippine economy, BPI noted. At the end of the day, this translates into something unsavory for those who depend on foreign exchange earnings.
“Remaining ahead of the pack is bad news for USD earners [such as BPOs, overseas Filipinos, and exporters]and import-competing [agriculture, manufacturing] firms,” the report added.