A Deeper Look into the Stronger Peso
Posted by butalidnl on 6 December 2007
In an earlier post, I pointed out that the peso-dollar exchange rate is basically a result of the dollar’s deteriorating value internationally. This happens in various ways:
First, there is what we could call the monetary effect. When Overseas Filipinos (OFs) who work in countries whose currencies (e.g. the Euro area) have appreciated vis-a-vis the dollar remit constant amounts in those currencies to the Philippines. Since a constant amount in these currencies would translate into a higher dollar amount, the amount of dollars that enter the Philippines would increase as a result.
Second, comes the effect of “hedging”. This happens when people take action in response to the expected fall in the dollar’s value. Foreign companies in the Philippines, for example, could delay their transfer of funds to the US (and the whole “dollar area”) for as long as possible; in the expectation of getting more dollars for their pesos later on.
Individuals or corporations with dollar accounts could draw down on these, preferring to keep more pesos rather than dollars.
Or companies could protect themselves from currency fluctuation by buying currency options or warrants. These instruments would ensure for instance that they would get an assured amount of pesos for their dollar income.
While these actions would be beneficial for the individuals or the companies themselves, these actions would contribute to the dollar’s devaluation vis-a-vis the peso.
Hedging, of course, could also be done by international “hedge funds”. These companies are quite adept at exploiting currency trends and interest rate differentials. With the peso appreciating vis-a-vis the dollar, and with the Philippine interest rates higher than those in the US, it pays for them to borrow dollars and invest these in Philippine peso bonds.
Third, is the so-called “budget” effect. Since a given amount of dollars would fetch a smaller and smaller amount in pesos, foreign-based entities (companies or individuals) who need to transfer a given amount of pesos would need to increase the amount of dollars that are sent to the Philippines. Thus, if a foreign company wants to invest in the Philippines, it may need to send more investment dollars inwards. [This does not necessarily mean that they will decide not to invest in the Philippines, since the dollar is deteriorating against most currencies anyway.] Some Overseas Filipinos will need to remit more dollars inwards if their recipients need specific amounts in pesos, e.g. for tuition fees.
The strength of the peso is also due, at least partly, to the increased stability of the Philippine economy. From an outsider’s point of view, the Philippines would indeed look like a good place to invest in – either in terms of direct investments or in stocks & bonds. The government tax revenues have increased, and the regular large inflow of money from OFs is also a big stabilizing force to the economy.
There are also no significant political threats to the economy’s stability. The so-called “armed threats” are all neutralized. The Moro rebels are now talking peace. Military rebels are pathetically ill-organized and ineffective. And the CPP-NPA is now effectively co-opted into the existing political system (with their sweetheart deals with local landlords/warlords, and their dependence on congressional pork-barrel funds). No section of the political/economic elite is advocating radical changes in the country’s economic policies.
see also Peso-Dollar Rate