LAST Friday, the last day of July, the peso closed at 45.74 to $1, the lowest close in five years. Although the local currency appreciated by a modest 0.2 percent through the first five months of the year, through June and July the peso has tumbled more than 2.4 percent.
For the year through July 31, the peso has lost about 2.3 percent of its value against the dollar.
The peso-dollar exchange rate, usually no more than a footnote to the daily business news, has attracted more attention lately because of its sudden volatility. The attention is not unwarranted, because in general, currency markets are much more sensitive than stock or bond markets. Individual transactions in the currency market are many times larger on average so that very small percentage changes represent very large amounts of money.
While attention is warranted, alarm probably is not—at least not yet. The drop in the peso is almost entirely due to the dollar’s gaining strength, rather than some trigger in the domestic economy. As long as the Philippine economy does not slow dramatically in the next quarter or two, the slide should reverse itself relatively soon; there are natural limits on how far in either direction the dollar can drive the peso.
Another factor we can take some comfort in is that the BSP and many market participants (i.e., Philippine banks) saw this coming. At the beginning of the year, peso-dollar forecasts for this year ranged from P44 to $1 to P46 to $1, with most favoring the upper end of that range; those predictions have turned out to be surprisingly accurate.
A falling peso is a boon to exporters and remittance recipients, at least up to a point, because it increases the peso value of the output; after all, wages are not paid in dollars, nor do Filipino consumers and businesses use them to pay for domestic goods and services. But of course the downside is, as the money supply grows, so does inflation. That the drop in the peso happened to correspond with a drop in inflation was a stroke of pure luck – it will allow the country a little more time to wring some benefits out of the prevailing circumstances.
Doing that is risky, however, like climbing into the ‘death zone’ on one of the world’s highest peaks—that altitude above 8,000 meters where there is not enough oxygen to support human life—with proper preparation and good weather, a fit person can function successfully in that environment for a short period of time, but is literally dying all the while. One misstep or bad decision, one unlucky break in the weather is all it takes to make for a very grim outcome.
In the financial system, oxygen is probably not a problem, but inflation is. A declining peso puts upward pressure on inflation, which erodes the premium the exchange rate adds to remittances and export receipts. Managing the money supply to maintain the balance to the positive side can only go on for so long before the currency market finds its equilibrium, and the advantages are lost; the window of time in which the BSP can see that point approaching and react to it appropriately through market intervention, or adjustment of monetary policy through interest rates and bank reserve requirements, may be very small.
And that is, if there is no significant change in current economic trends, no sharp external shock like a jump in oil prices or a sharper contraction in the Chinese economy.
The consequences of that, or of the BSP simply failing to go back down the mountain and get some air at the right time are higher inflation growing at a rate that is probably a little faster than the central bank can control through its normal monetary tools, lower consumption, and a bigger negative trade gap.
The BSP, however, is confident it has things under control, and that certainly seems to be the case at the moment. But we are in a very dangerous place, where things can go wrong even if we do everything right.