Should we worry about the peso depreciation?

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By Victor A. Abola

AS THE peso-dollar exchange rate crossed the P53.00/$1.00 on June 11th, a lot of people, including foreign analysts, raised their “worried” flag. Indeed, the next days thereafter the peso slid further to some 5.8% higher than the P50.40/$1.00 average in 2017.

But should we worry?

The answer should depend on the factors that are driving the peso’s weakness.

First, the US dollar has been strengthening since the end of Q1-2018. There are several reasons for this. IMF projects that the US economic growth to accelerate 2.9% this year compared to 2.3% in 2017.

Apart from the growth momentum, the Trump’s tax cuts get to be felt by individuals and corporations starting Q2 2018.

Next, the same tax reform tries to attract back to the US some $2 trillion of cash held by US multinationals abroad. Even if half of that returns, that would add significant demand for the greenback.

Finally, we have the Fed raising policy rates now to 1.75% and so 6-month T-bills yield 2.06% while in Germany the 6-month yield is -0.63% on June 13th. It becomes attractive for German institutions to invest in US Treasuries because of the large differential.

Second, foreign stock and bond investors are selling off their peso-denominated financial assets as they stand to lose with a peso depreciation. Foreigners have been net sellers in the local stock market by a total of P52.6-B (~$1.0-B) from February to May this year.

Third, the Philippine balance of trade has been deteriorating and has reached a record -$3.6-B in April 2018.

For the first four months, this amounted to $12.2-B which if multiplied by 3 (simple annualization) yields $36.6-B which will be more than 20% higher than a year ago. However, this may not be viewed too badly as imports of capital goods (additions to productive capacity) have shown robust growth (+14.1% YTD April vs. 10.5% YTD for total imports, and accounted for 1/3 of total imports for the period).

On the other side of the issue, we can look at the fact that if we take a longer view, the peso has actually appreciated by 4.6% from 2004 to June 13, 2018, while our neighbors Indonesia and Vietnam had large cumulative depreciations in excess of 47% during this period. Malaysia also shows net depreciation during the period.

Besides, there are positive effects of the peso depreciation. The most obvious effect of this would be to discourage imports and prod more exports, thus, reducing the trade deficits over the medium term. And because more production is done locally, it will boost employment generation.

The second positive effect is that it will increase peso incomes of OFW families, exporters and those that supply raw materials to exporters. With an estimated 10 million OFWs and with an average family size of 4.6, the peso slide benefits some 46 million families. Add to that the number of families dependent on exports, which account for some 30% of GDP, plus those that supply raw materials to exporters, and we easily obtain the conclusion that a vast majority of Filipino families benefit from the higher peso-dollar exchange rate.

Finally, both our research and that of BSP would show that a 10% peso depreciation adds only around 0.5% to inflation. If the FX rate averages some 6% higher for the year, the resulting additional inflation would only be 0.3%. Besides, the consumers of imported goods are the higher income classes rather than the poor.

In short, while the current weakness of the peso might seem negative, its impact both for the short and medium term is net positive.


Victor A. Abola is a senior economist and assistant professor at the School of Economics of the University of Asia and the Pacific.