The talk of the town is the Philippine peso which has devalued by 15% in the last year, reportedly among the worst in the region. President Marcos publicly committed to protect the peso as has DOF Sec. Diokno. Rep. Sandro Marcos weighed in stating correctly the peso weakness is partly dollar induced.
The concerted talk tells us a) there is a problem and b) there could be worse to come. DOF Sec. Diokno vowed to defend the peso at P60/USD with a $10 billion war chest. Drawing a line on the sand and disclosing the size of the ammunition can be dangerous. One, it invariably means the peso will eventually move to that level. Two, once breached nobody will believe you after that.
Right now the peso is holding at around P59/USD with BSP intervention but it is unclear how long that will last. In August we posted a trade deficit of $6 billion, the largest single month figure since 1957. Our Jan-Aug.deficit was $42 billion, 68% higher than a year ago. Our foreign exchange reserves dropped from $108 billion six months ago to $93 billion. Philippine inflation rose to over 7% in Sept. its seventh month in a row.
The Philippines completed a $2 billion USD bond offering at an interest rate 200 basis points higher than our last loan. Our interest bill is heading higher.
In July 2022, NEDA Sec. Arsi Balisacan said: “The Philippines is far from stagflation”, the dreaded combination of inflation and economic stagnation. Arsi now says: “We are monitoring the developments closely. We can also deploy our monetary tools like interest rates so we can intervene in the financial markets to obtain these included in the weakening of the peso.” I am not sure what he meant but it sounds ominous.
He reiterated that “rising inflation is temporary”. This mirrored what the Fed Chairman said last year of U.S. inflation and he is now having to eat his words. Not only was Powell wrong, he lost his credibility which partly explains the volatility and over 20% drop in the stock market this year.
Defending a currency is a tricky thing. It involves three things: One, credibility. Our leaders are trying to talk the peso up but will not succeed unless the markets believe our Government is doing what it needs to finally fix our economy. Two, having the ammunition to successfully intervene. The announced $10 billion budget (11% of our international reserves) may sound like a lot but is not when faced with the power of the market. Three, an element of surprise. The BSP should not telegraph its intervention price nor the size of its war chest. Once these are known the market will position accordingly.
If these don’t work the BSP may impose increasingly harsher capital controls which is the road to perdition. Foreign investors head for the exit, the locals panic leading to a run on the currency. This fuels inflation which just adds to the problem.
The only way to halt a slide in the currency is to get the markets on side. Once investors believe in our actions – not our words – the sentiment will quickly change. The British pound, the gilt market (the U.K. version of U.S. Treasuries) and the Truss Government collapsed last week after the latter promised to cut taxes. However the British pound reversed itself as soon as the change in policy and Government were announced.
How do we get the markets to believe in our economy? Here are possible solutions some worst than others:
1.Stop the corruption – This is more effective than a $10 billion forex war chest. It will restore investor confidence.
2. Defer the corporate tax cuts under CREATE- Studies in the U.S. and the U.K. show tax cuts do not result in additional investment or productivity. They simply go to higher dividends and share buy backs benefitting the rich not the poor. Our monetary and fiscal policies are now at cross purposes when they should be moving in tandem: The BSP is raising interest rates to quell demand while the DOF cut taxes to propel demand.
3. Impose a tax on super-profits – Some companies have benefited disproportionately from the peso devaluation and the accompanying inflation. In the U.S. a tax on oil companies is being considered, in the UK a tax on banks. Some local companies in the extractive industries and banks with unusual forex profits may fall under this category.
4. Realign the Budget – The 2023 Budget contains monies for among others an Intelligence Fund for the Office of the Vice-President (to establish provincial OVP offices) and the DepEd (to track criminals preying on the young). Is Sara building a state within a state? The DepEd needs money for the intelligence of our kids not for that of the OVP however lacking. Then there is some reported P370 billion in Lump Sum Appropriations which is the politically correct term for Pork Barrel. The money saved could go to social amelioration.
5. Prioritize the low lying fruits while building for the future – In the short term we should go all in on dollar earners like tourism and OFWs where the benefits are immediate and the capital investments modest. This involves a unified approach by all the stakeholders – the hospitality industry, airlines, local and national Government and our international outposts – targeting the Filipino diaspora and foreign travelers. We should upgrade OFW skills to address the world needs for mid level workers e.g. in airport ground handling.
In the medium term we should build our infrastructure, education and agriculture.
6. Tighten our belts – Government needs to cut costs and dispense with frivolities. We should start with a freeze on new hires while we study how we can deliver the same services with less. We must dispense with public displays of ostentation whether funded privately or publicly.
7. Stop relying on interest rates alone to fix the problem – This is what happens when monetary economists are asked to address a problem. We need a holistic approach to inflation. One needs a bazooka to stop an onslaught, not a single shooter.
8. Wield the stick – SMC Power recently threatened to cancel their energy supply contract with Meralco because of some P 15 billion in annual losses from the fixed price arrangements. This will result in a loss of energy supply at a time of looming power shortages. The Government cannot allow it to happen: SMC Power seemingly made a commercial error in agreeing to a fixed price contract but the consumer cannot be made to pay for it. There could be a compromise where everybody agrees to take a hit under some form of Ch. 11 protection; in the interest of national security. The case of Manila Water comes to mind.
9. Increase the Conditional Cash Transfer program in an efficient way – Research has shown that CCTs are the best way to provide social relief. The problem is that like Ayuda most of it gets caught in the bureaucracy and corruption in the fund administration.
10. Raise the minimum wage – This is a political solution to an economic problem and will not work given our high unemployment and under employment.
11. Price ceilings – This is generally a bad idea except in instances of clear price gouging. Even then the solution is not in setting a price cap but in punishing those operating in restraint of trade.
11. Moral suasion- This includes persuading banks to lighten whatever their overbought dollar positions which is hurting the economy. This could help for while.
11. Do not politicize the problem – A senior economic manager called our economic problems “easily manageable”. Our leaders must not lose the public’s trust with statements that defy reality.
Defending the peso through outright intervention is a one dimensional, end-of pipe solution. It could deplete our international reserves without addressing the underlying issues like focusing, aligning our fiscal and monetary policies, living in austerity and addressing gut concerns like corruption. These and not the peso are arguably what needs fixing.