ON Tuesday, the Bangko Sentral ng Pilipinas (BSP) released the consumer price index for February, which showed that inflation accelerated to 3.3 percent last month. That result, when taken together with the recent change in the peso-dollar exchange rate, is an indication that overall purchasing power in the Philippines has passed an apex of sorts, and is now declining.
To explain how, let’s first review how inflation is calculated. Inflation (or deflation) is a measure of how much prices for a representative “basket” of goods—which includes tangible items such as food, fuel, electricity, booze, cigarettes and intangibles such as transport costs apart from fuel and housing costs—change in a defined period from the previous period, beginning with an arbitrary baseline.
Here in the Philippines, the baseline is set to the year 2006; the prices of the items in the basket at that time were all made equivalent to 100 (percent), and the inflation rate that is published each month defines how much that month’s prices have increased from the same month a year earlier. Although inflation is reported on a periodic basis, it is also cumulative; with inflation for 2017 so far averaging 2.7 percent, something that cost P100 at the end of 2006 now costs P156.91.
Inflation is one of the two fundamental factors that determine consumer buying power. The other factor is the value of the peso, which has been declining over the past few months.
Higher inflation, or more precisely, higher prices, reduces consumer buying power, but since the Philippine economy is export-driven (the huge flow of remittances functions the same way as export income), a depreciating peso increases buying power. Although some quarters have expressed some concern over the decline of the peso—toward the end of last month, the Philippine Chamber of Commerce and Industry said it might be taken as a sign of diminishing confidence in the economy—the consensus has been that the recent drop in the peso has been beneficial. Consumers, particularly those who collect remittance inflows, have more pesos to spend for the same amount of dollars received; likewise, exporters earn more local currency for their goods at the same dollar prices.
So long as prices do not increase at a rate faster than the peso declines, consumers technically have more money in their pockets, which is generally considered a good thing for the economy. BSP data shows that the average exchange rate in February 2017 was P49.961 to $1, while the average in February 2016 was P47.636; that equals a decline in the value of the peso of 4.9 percent. At the same time, inflation was 3.3 percent, so in other words, the spending power of the average Filipino increased by 1.6 percent year-on-year. For a worker taking home P20,000 per month, that gives him P320 more to spend per month, not a great amount on an individual scale, but a significant boost to the economy when multiplied by several million times. More importantly, perhaps, it is objective confirmation that the assertions of economic analysts and policymakers that the depreciation of the peso should not alarm anyone are correct, or at least have been up until now.
That just changed with February’s higher inflation, which was an increase of 0.6 percent over January. The depreciation of the peso over the same period was 0.45 percent (P49.961 at the end of February against P49.736 at the end of January). That means that effective spending power just decreased by 0.15 percent—a very small amount, certainly (it makes a difference of about P30 to our P20,000/month example wage earner), but a dip into the negative, nonetheless.
The prognosis right now for these two economic factors is that inflation will continue to increase toward 4 percent, the upper limit of the BSP’s target range, while the peso will continue to depreciate gradually toward P51 or P52 to $1. If that is allowed to happen, it will slow the overall growth of the economy, because it will accelerate the decline in spending power. Inflation now is being driven by external factors, such as higher oil prices, but continued peso depreciation will eventually aggravate it; for one thing, it will push up the price of imports, which are a significant source of consumption.
Given that economic conditions in the Philippines have been relatively benign for an extended period of time, the central bank’s control of the peso exchange rate and its management of inflation have been approached as two different tasks, but that may no longer be possible. With BSP governor Amando Tetangco Jr. headed for retirement, his successor will not only have a big pair of shoes to fill, he will have to be an expert tightrope walker in them to strike the delicate balance between managing the peso and managing inflation.