BSP should more clearly address peso instability

ON Thursday, the same day that the Monetary Board of the Bangko Sentral ng Pilipinas (BSP) raised the central bank’s benchmark interest rate by 50 basis points to 4.25 percent, the peso shed another 49 centavos to close at P58.49 to the dollar. While the BSP has traditionally taken a hands-off approach to the peso — it does not target a particular exchange rate, and rarely intervenes in the currency market — the rapid decline in the peso’s value relative to the US dollar, and even more so, its unusual volatility has caused a great deal of concern among market watchers, investors and consumers.

Intervening in some manner in the currency market would be a drastic step, and the decision to do so is complicated by the great many economic factors that need to be taken into account. Thus, it might be reckless to simply suggest that is what the BSP should do. However, we do believe that the BSP should take some firmer steps — up to and including market intervention, if that is warranted — to alleviate concerns over the peso’s apparent runaway decline and its recent extreme volatility.

The BSP has repeatedly said that the drop in the peso’s value, which stood at just under P51 to $1 at the end of 2021 and has lost nearly P7.50 this year, is not due to “structural factors,” or weaknesses in the Philippine economy, but rather external pressure. This external pressure comes from the strengthening dollar, which has been driven by the US Federal Reserve’s aggressive raising of its interest rates throughout the year, affecting other currencies worldwide.

Inflation, the big problem

The BSP’s assertion is mostly correct. But on the other hand, if the Philippine economy was structurally stronger, the peso’s value would be affected less than it is, even though some decline would still be inevitable. The biggest problem is inflation which remains well above the ideal range. The BSP is aware of this, of course, and has made clear that its own interest rate adjustments are intended to address inflation. However, a declining peso, particularly if it is declining rapidly as it is at the moment, tends to increase inflation and reduce or even cancel out the effect of interest rate action. Thus, it is imperative that the BSP address the issue in whatever manner will help to calm the currency market.

Again, we are not suggesting that drastic action is necessarily the solution, because it may not be. There are benefits and hazards to the changing peso value whether it is declining or gaining, and these have to be carefully balanced. A falling peso, as the situation is at present, is a positive for exports, BPO earnings and remittances in dollars or in currencies that have not weakened as much as the peso increase, and as those make up a significant part of the economy, that is a clear benefit. On the other hand, a falling peso increases the cost of imports, which can drive up inflation, and increases the cost of servicing the foreign component of government debt. At some point, the drawbacks of the declining peso will outweigh the benefits — for example, higher export earnings or remittances will lose buying power due to higher inflation — so the peso’s value must be managed.

As noted above, it has been the BSP’s long-standing policy to allow the market to manage it, and for the most part this has been completely effective. It may still be, but there is more uncertainty about that now than at any time in recent memory, and with inflation worries increasing — we have seen forecasts in recent days from analysts who have been generally quite accurate ranging as high as 7.7 percent for the fourth quarter — it is time for the BSP to speak up: Communicate clearly under what circumstances some form of support for the peso might become necessary, and what form that support might take if it comes to that, whether further interest rate adjustments, adjustments to banks’ reserve requirements, or direct market intervention. Simply informing the market that a “safety net” is available if necessary will likely serve to reduce volatility, perhaps enough to let the market’s “invisible hand” find the most useful level for the peso on its own without any further action.