Central bank with a dual role?

(Last of two parts)

We reiterate what we started with in the last column, and that is the crucial role of good governance in economic management. Weakening the Philippine peso is not the most important economic reform especially under our current circumstances.

It’s interesting that ANZ Research’s latest report also proposed to the Philippine monetary authorities that they “should consider a more competitive exchange rate.” However, it failed to help clarify how making the peso more competitive could “boost exports, attract investment and support a shift toward productivity-led growth” beyond saying that a noncompetitive peso “caused domestic industries to sharply decline as the real appreciation of the currency made imports cheaper.”

Let’s talk about the real exchange rate of the peso.

Indeed, it is not exactly the peso’s nominal exchange rate relative to the US dollar that is relevant in assessing the dynamics of our external payment position. It is the peso’s real effective exchange rate (REER). Let it be made clear that the real appreciation of the peso is not driven exclusively by nominal exchange rate adjustments, no matter how large, but also by domestic inflation against those of other countries. Domestic inflation climbs when the weak currency makes imports more costly. This is apart from how other trading economies’ currencies are behaving. Off hand, we need to caution ourselves against the potential of competitive devaluation among us in Asia, or even among the leading currencies.

A deliberate weakening of the peso will not even make a dent in how our trading partners’ currencies will move one way or the other. Bangko Sentral ng Pilipinas (BSP), no matter how smart it is, cannot elevate the other countries’ inflation rate to make the differential move in the Philippines’ favor.

In the past six years, the peso’s REER, as computed and released publicly by the BSP, appreciated five times, with some depreciation only in 2022. From 2019 through 2021, it was the strong peso — it firmed up from P51.80 a dollar in 2019 to P49.60 in 2020 to P49.20 in 2021 — that would explain the loss in competitiveness. Not to be missed, the increase in the inflation rate from 2.4% in 2020 to 3.9% in 2021 also contributed to that loss. In 2022, the peso became more competitive in real terms when it weakened to P54.50 a dollar, depreciating by over P5 or nearly 10%. But we also saw a significant jump in the domestic inflation rate from 3.9% to 5.8%. The inflationary movement continued in 2023 despite the sustained weakening of the peso, REER took a reversal, resulting in a loss of competitiveness. The weakening of the peso-dollar rate in 2024 failed to arrest the REER depreciation, even as the inflation rate began to ease. We need to know that the inflation rates in other countries have remained generally moderate.

Obviously, external competitiveness is not just a function of nominal exchange rates but is also driven by price movements that could in turn surge due to currency weakening. Undermining the currency initially motivates some gains in competitiveness, but this could just be more than dampened by higher inflation.

Yes, weakening the currency could initially encourage more exports and discourage more imports. But since a great bulk of our exports are import-dependent, there is no guarantee that such a policy could bring net benefits to the economy. We need no less than a restructuring of our production and distribution system, as well as logistics and finance. Nonmonetary public policy should focus on productivity-enhancing expenditure on infrastructure, quality public health and education, and greater research and development to usher in IT-driven innovation in all sectors of the economy.

The other challenge to a competitive peso policy, even to achieve what ANZ Research calls “a mildly undervalued exchange rate, whenever possible,” is that the exchange rate, being a price of a currency relative to other currencies, simply reflects global economic and financial realities.

Today, the peso is strong because the US dollar is undeniably weak.

How does one solve the fundamental flaw in the Trump policies of taxing US imports to support corporate tax cuts, abet military conflict and sell military hardware, and spend billions of dollars maintaining numerous military bases across the world, not to mention billions of dollars spent on intelligence work? This is beyond us, and this is beyond the monetary policy of the BSP.

How does one prevent the sell-off of US global bonds by the big economies, accelerating as it does on the heels of a US Treasury debacle? It is difficult to arrest such a sell-off because the US fiscal trajectory is not exactly comforting to investors in US Treasuries. Investors could only expect further deterioration in the US fiscal deficit as Moody’s downgraded US credit ratings. Repricing risks has resulted in further weakening of the US currency, and as expected, the peso and other currencies’ exogenous appreciation. This is beyond us, and this is beyond the monetary policy of the BSP.

How does one expect the Philippine central bank to sustain engineering the weakness of the peso by, say, P5-P10 or more than 10% and defy market forces? This means we want the BSP to buy and accumulate billions of dollars in reserves and flood the market with pesos. In effect, the BSP would be crowding out private sector demand for US dollars and amplify the market’s preference for pesos. This could be seriously inflationary. Imports would be many times more expensive, especially imported food and fuel commodities. While exporters would receive some windfall due to the peso depreciation, they would also have to face the challenge of costly inputs and higher cost of external debt service. Many corporates and the National Government in aggregate owe around $138 billion or 30% of GDP.

The risk of this collateral impact of a weak currency and higher debt service needs is the possible erosion of investor confidence. Last week, we highlighted the fruitless depreciation of the local currency — exports failed to improve, while imports continued to surge. The evidence is not conclusive. When investor confidence falls, it would be a tall order building it up again.

No wonder, even the ANZ Research itself recognized that such a strategy “carries risks.”

Some quarters believe that to help bring this about, Congress should pass a law amending the BSP charter to dilute its primary mandate of keeping prices stable by assigning it as well as the responsibility of promoting growth and full employment. This must be based on the wrong notion that if monetary policy is too focused on inflation management, economic growth and employment are likely to fall below the potential growth of the economy. Financial markets are claimed to be likely less stable. Congress should be properly advised that this is a dangerous proposition.

Monetary management is more than simply a matter of choosing from a schedule or combination of a little or more inflation or employment. Monetary policy that leverages employment and growth at the expense of higher inflation would simply perpetuate higher inflation with very feeble gains in jobs and output.

Many central banks with dual roles in economic management were hamstrung precisely by these competing goals of promoting growth and employment normally by an accommodative monetary policy and maintaining price stability through cautious monetary policy. Many end up achieving neither of these goals.

Economic history and empirical evidence show that central banks can best help in economic management toward higher economic growth and a stable financial system through a strong commitment to price stability. Contrary to some misrepresentation, there is little evidence, and this is always denied, that expansionary monetary policy can expand economic growth and job opportunities. Likewise, no one can claim that high inflation encourages financial stability.

Latin America is replete with country experiences with runaway inflation and how it devastated their financial system and undermined their real economy. On the other hand, the US Fed, despite having dual roles, focused on price stability and succeeded in keeping it. The variability of output was reduced in the 1990s and the first six years of the 2000s. With inflation expectations in the US well-anchored, the US Fed acquired the flexibility to provide liquidity to the financial system and reduce the cost of money via lower interest rates.

Our experience in the 1980s should never be forgotten that culminated in our own Congress abolishing the old Central Bank of the Philippines (CBP) and replacing it with the new BSP, with the primary mandate of promoting price stability. The old CBP, aside from its mandate to promote monetary stability, was also saddled with the responsibility of preserving the international value of the peso and its convertibility, as well as promoting output, employment and income!

The transition to a singular mandate was in keeping with the modern trend in central banking with a singular role and independence.

An independent BSP with a focus on stable prices has demonstrated such good convergence between a firm commitment to low and stable inflation and high and sustainable economic growth, as well as a strong banking system. In the past 10 years with price stability, economic growth has been steady and sustainable, with both unemployment and underemployment down from 15-20 years earlier.

Finally, the public should be disabused of this idea that central banks, like the BSP, are compelled to restrict inflation to near 0 when its target is between 2-4%, and in the process kill the economy. But our monetary authorities have been wiser in that they exercised sound judgment and discipline to ensure that inflation does not swing to either extreme. The BSP has not been always correct in its forecasts and decisions, but because of its demonstrated competence and integrity, the public trusts that during such instances, the BSP will rectify its mistakes, pick up the pieces and keep its eye on the ball.

This is what matters.