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MANILA - The Philippines is in an enviable position these days as it is the second fastest-growing economy in Asia, thanks in part to the Bangko Sentral ng Pilipinas, economists say.
This is the only one place that you can't blame monetary policy, as the Philippines reaps the benefits of effective inflation targeting, Tim Condon, ING Bank chief economist for Asia, recently told the press.
The country has been enjoying low inflation rates in recent years, fueling a property boom and the stock market. There is enough money to go around to bankroll corporate expansion and household consumption, helping the Philippines achieve its surprise 6.4 percent economic growth in the first quarter this year.
Bank of America - Merrill Lynch's Victoria Ip said the Philippines, like Indonesia, has become the darling of foreign investors. They have been investing in fixed income assets, the stock market, or even direct placements in the manufacturing or business process outsourcing industries.
This, however, has a problematic side: the more dollars that enter the country, the higher the peso’s value vis-à-vis the greenback. While it reduces the debt-servicing costs of the Philippine government, a strong local currency also hobbles the country's export industry. Imports become cheaper, too, threatening the local manufacturing industry.
A stronger peso also undermines the buying power of OFW remittances, which have fueled the Philippines’ main growth driver, consumer spending.
Filomeno Sta. Ana, executive director of Action for Economic Reforms, said it is good that the BSP is more sympathetic towards the real economy by defending the dollar from time to time, smoothening the volatilities.
But the question remains: Does the BSP have the tools to address this foreign exchange conundrum without losing its focus on its main task of keeping inflation at bay, Sta. Ana asked.
ING's Condon said the BSP is one of few central banks around the world that use a different approach when it comes to keeping its currency competitive. He said the BSP's approach, which he describes as a “smart move,” has always been to allow short-term interest rates to plunge when the peso has become a one-way bet, thus, taking the pressure off the local currency.
This is a marked contrast to other market-oriented central banks like the Bank of Korea, which continuously defend the US dollar to keep the won fairly competititve, and exports of Samsungs and Hyundais sustainable.
Condon, however, is "worried" that the BSP is now adopting the stance of BOK and in a big way defending the dollar rather than letting short-term interest rates fall.
Condon's colleague from ING Bank N.V. Manila, Jose Mario I. Cuyegkeng, explains: "Once in a while they're in the market just to smoothen out the volatility unlike other central banks are there in a large way over a prolonged period. They also look at other market-oriented economies."
This means the BSP buys dollars in the forex market on a given trading day to keep the peso from becoming too strong.
But at the end of the day, Cuyegkeng said, the BSP would still have to keep in mind its primary mandate of balancing economic growth amid a slowing global economy by cutting interest rates. An impressive growth story, on the flipside, invites more dollars to the country.
"It's a difficult balancing act for the central bank. We're hoping the swap rates would cure that but the fundamentals point to a strong peso. At the moment swap rates are secondary, interest rates don't work," Cuyegkeng said.
"They're at a crossroads actually," he said.
The International Monetary Fund has recognized this difficult balancing act by saying that the challenge now for Philippine authorities is how to keep macro stability amid high capital inflows and robust growth expectations.
AER's Sta. Ana is calling on the BSP to install capital controls---or measures that would make it less easy for "hot money" to enter the country---to keep the peso from strengthening too much. Capital controls would solve the forex problem without sacrificing monetary authorities' need to cut interest rates.
"The authorities may also be considering soft forms of capital controls to cope with fund inflows. By dampening inflows, the authorities could reduce the magnitude of destabilizing outflows during times of risk aversion,” Singapore-based DBS said.
Merrill Lynch's Johannes Jooste, however, said capital controls in any form would not be a smart move since it sends negative signals to investors. It might be a short-term fix but this would be detrimental when portfolio investments suddenly leave the country when Europe and the US start showing signs of stability.
The BSP so far has restricted foreign funds’ access to its special deposit accounts, which has facilitated currency carry trade.
"So far they have shunned away from capital controls. It's one of the positive things. They try to so far but I don't think the speculators are here," ING's Cuyegkeng said.
Now the BSP has hinted that an interest rate cut is in the offing "to protect the inflation target on the downside.” Its policy-making Monetary Board meets later today.
How would it now keep the peso from straying too far from government forecast?
"The central bank has a lot on [its] sleeves and I think the last would be a rate cut," Cuyegkeng said.
So does Barclays Capital, DBS and Metrobank.
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