The Philippine peso is seen to hit P46 to a dollar in the weeks ahead as pressures from portfolio rebalancing continues, according to think tank Global Source Partners.
In a research report titled “Peso In A Free Fall?” the think tank said that the peso’s “free fall” has raised worries that the country’s external payments position may come under pressure, as imports to fund reconstruction and other infrastructure needs increase this year.
It said that the peso depreciation was seen as a region-wide response to continuing speculation about the likely strength of the United States economic recovery and its impact on the speed of the Federal Reserve taper on its bond-buying program.
But Global Source Partners said that government economic managers see relatively less risk of global financial market turmoil that could negatively affect the country’s domestic growth prospects, on the account of its strong external payments position.
It also said that the weaker peso is seen to reverse some of the accumulated loss in competitiveness over the past 10 years versus trading partners, giving exports an extra boost just as demand in developed economies rises.
“Certainly, peso depreciation favors the monetary authorities’ balance sheet,” it stated.
Meanwhile, the think tank explained why the peso is depreciating more than other Asian currencies despite the country’s strong external payments position.
“It appears that the answer lies in the comparatively low domestic yields on peso instruments vs. other Asian fixed income and by extension, a narrower differential vs. US treasury yields,” it said, noting that the Philippine short-term treasury yields were driven to near zero late last year, as the Bangko Sentral ng Pilipinas (BSP) closed its special deposit account (SDA) window to trust accounts, contributing to a 36.5-percent rise in domestic money supply by end-November.
“While interest rates have since risen, they remain rather paltry, especially with the BSP projecting higher local inflation ahead, which analysts fear may climb even higher with the peso’s depreciation,” it stated.
‘Sticky’ domestic interest rates
The think tank mentioned that there are several factors behind “sticky” domestic interest rates, one is monies released from SDAs largely lay idle in bank deposits and will take time to be deployed for production; and the second is that government this year opted to fund a portion of its budgetary requirements internationally.
“While the funds were supposed to be used to retire foreign debts, and were thus largely peso-neutral, it would reduce the Treasury’s local borrowing needs,” it said.
Moreover, Global Source Partners said that signals from the BSP are that expected increases in inflation will be manageable and thus, policy rates will remain on hold in the near term. The BSP said that inflation rate outlook for 2014 was at 4.5 percent, and 2015 at 3.2 percent.
The think tank said that these suggest that interest rates will remain low for a while, perhaps through midyear, which may mean continued currency weakness.
“And to the extent that continuing portfolio rebalancing by both residents and nonresidents leads to capital outflows, there may be additional pressure on the peso. We would not be surprised if it tests the P46 to a dollar level in the weeks ahead,” it said.
However, Global Source Partners said that there is a more than even chance of the peso settling at about P43 a dollar to P44 a dollar by yearend, while reverting to a P40 a dollar exchange rate is highly unlikely.
“We think that the improving outlook on current account earnings, particularly electronics exports, BPO [business process outsourcing]services and remittances, due to the prospect of improved growth in advanced countries especially the US, will in time lead the peso to reverse course,” it said.