Softening the peso

Ben D. Kritz

Ben D. Kritz

For those of you who are fans of obtuse government language—and really, aren’t we all—here’s a gem from Bangko Sentral ng Pilipinas (BSP) Governor Amando Tetangco Jr., who was asked last week about the implications of a stronger dollar:

“As the US economic growth gains traction, we may see the US dollar further strengthen. Like other emerging-market economy currencies, the peso is sensitive to external developments. There will, therefore, likely be bouts of volatility and potentially sharp movements in the peso as the US dollar strengthens,” Tetangco said.

“Nevertheless, we expect the peso to remain fundamentally supported. As we have seen in the past, investors will revert to the idiosyncratic characteristics of the economy.”

The next time I have to make a powerpoint presentation, no matter what the topic, I think I will add a slide that says, “Revert to the idiosyncratic characteristics.” And for that I will probably have to send a pizza or something to Governor Tetangco’s office as a royalty, but it will be a small price to pay for the privilege of using such a pearl of wisdom.

Interpreting the statements of central bankers is a kind of art, because the job of being a central banker necessarily requires one to be unclear. The central bank simply cannot telegraph its policy intentions; to do so would be to tip the markets, and spoil intended effects of the policy decision.

For example, when the BSP raises interest rates, one side effect is that it causes bond yields to rise. If the market knew beforehand, however, that interest rates would be raised at a particular time, the anticipation of higher yields would in all likelihood increase bond buying, which drives yields lower.

What Tetangco was talking about with respect to the peso was the BSP’s energetic participation in the currency market. In order to prevent the value of the peso from fluctuating wildly, the BSP by using some of the country’s foreign reserves buys or sells dollars in order to try to keep the peso within an acceptable exchange rate range (the official target band is between P42 and P45 to $1). This is completely normal monetary policy management that most central banks practice to some degree, but again, because of the effect the knowledge would have on the market, they cannot be exactly forthright about it. Everyone in the market knows the BSP trades to control the peso and the BSP knows everyone knows that, but because it is not openly discussed no one knows exactly when and on what scale the BSP will intervene until after it happens. That small bit of uncertainty is enough to make assumptions of market intervention too risky, and as a consequence, the currency market functions more or less naturally.

Another quirk of central banker language is that it is almost never unequivocal. Central bankers realize that any forecast is an assumption; it may be an extraordinarily well-informed assumption, but the risk of variation cannot be entirely eliminated. Therefore the only way in which the assumption can be expressed is as a loose probability, with statements which begin with phrasing such as, “We may see . . . ,” “There is a likelihood that . . . ,” and “Potentially . . . ”

With that, we can now interpret Tetangco’s seemingly opaque statement. First, the BSP assumes the dollar will continue to rise relative to other currencies. That is not at all daring; recent indicators showing that the US economy has definitely awakened from its long slumber and the general economic advantages that come from the extended oil price rout all point to a stronger US currency.

Second, because the peso is closely pegged to the dollar in practice (though not officially), the relative value of the peso is almost entirely dependent on “external developments,” i.e., changes in the dollar’s value, rather than internal factors. That means that the currency market will continue to be reactive, which in turn means that volatility—the magnitude of changes in the peso’s exchange value during a trading session and from day-to-day—will be high.

That makes the last part of Tetangco’s statement an apparent contradiction; if the peso will be driven by “external developments,” then it is not “fundamentally supported.” If it is supported at all, it is by the one idiosyncrasy (though substantial, it is not particularly unusual among emerging economies) Tetangco can refer to, the Philippines’ heavy reliance on a steady inflow of foreign cash through remittances and the BPO sector.

That income has proven to be remarkably stable despite its risks, and the BSP has put it to good use so far—while the peso has weakened, the decline has been rather gradual. With no sign now that the river of money will stop flowing before mid-year, however, how long the BSP can keep it up is another question.

The answer is, probably for most of the year and perhaps even longer, given foreign reserves that are again approaching the $80 billion level. How long the BSP feels intervention will be necessary determines how low the peso will go. As the central bank typically errs on the side of caution it would most likely plan for a longer timeframe; that, along with the boost to exports a weaker currency provides suggests that the peso could decline significantly this year.


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