Exchange Rate

September 2018

THE EXCHANGE RATE

KEY DEFINITIONS AND CONCEPTS

1. How is the exchange rate defined?

The exchange rate is the price of a unit of foreign currency in terms of the
domestic currency. In the Philippines, for instance, the exchange rate is
conventionally expressed as the value of one US dollar in peso equivalent.
For example, US$1 = P53.00.

In every exchange rate quotation, therefore, there are always two

currencies involved.

2. Why is the exchange rate important?

The exchange rate is important for several reasons:

 It serves as the basic link between the local and the overseas market for
various goods, services and financial assets. Using the exchange rate,
we are able to compare prices of goods, services, and assets quoted in
different currencies.
 Exchange rate movements can affect actual inflation as well as
expectations about future price movements. Changes in the exchange
rate tend to directly affect domestic prices of imported goods and
services. A stronger peso lowers the peso prices of imported goods as
well as import-intensive services such as transport, thereby lowering the
rate of inflation. For instance, an increase in the value of the peso from
US$1:P50 to US$1:P40 will lower the price of a $1 per liter gasoline
from P50.00 (P50 X $1) to P40.00 (P40X $1).
 Exchange rate movements can affect the country’s external sector
through its impact on foreign trade. An appreciation of the peso, for
instance, could lower the price competitiveness of our exports versus
the products of those competitor countries whose currencies have not
changed in value.
 The exchange rate affects the cost of servicing (principal and interest
payments) on the country’s foreign debt. A peso appreciation reduces
the amount of pesos needed to buy foreign exchange to pay interest
and maturing obligations.

3. How is the exchange rate determined?

Under the system of freely floating exchange rates, the value of the dollar in
terms of the peso, like any commodity or service being sold in the market, is
determined by the forces of supply and demand. Under a fixed exchange
rate system, a par value rate is set between the peso and the dollar by the
central bank. The par value may be adjusted from time to time.

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4. How does the exchange rate change?

Under a floating exchange rate system, if more dollars are demanded than
are offered, the price of the dollar in terms of the peso will tend to increase;
that is, it will cost more pesos to acquire one dollar. If, on the other hand,
more dollars are offered than are demanded, the value of the dollar in terms
of the peso will tend to decrease; that is, it will cost less pesos to acquire
one dollar. In contrast, under a fixed rate system, a change in the exchange
rate is effected through an official announcement by the central bank.

5. What is the country’s foreign exchange policy?

At present, the country's exchange rate policy supports a freely floating

exchange rate system whereby the Bangko Sentral ng Pilipinas (BSP)
leaves the determination of the exchange rate to market forces. Under a
market-determined exchange rate framework, the BSP does not set the
foreign exchange rate but instead allows the value of the peso to be
determined by the supply of and demand for foreign exchange.

Thus, the BSP’s participation in the foreign exchange market is limited to

tempering sharp fluctuations in the exchange rate. On such occasions of
excessive movements, the BSP enters the market mainly to maintain order
and stability. When warranted, the BSP also stands ready to provide some
liquidity and ensure that legitimate demands for foreign currency are
satisfied.

6. How is foreign exchange traded in the market?

In the Philippines, banks trade foreign exchange using an electronic trading

platform called the Philippine Dealing and Exchange Corp. (PDEx) through
any of the following ways: Reuters or Bloomberg dealing, over-the-counter,
or via brokers. The PDEx captures all spot transactions (which involve the
purchase or sale of a foreign currency for immediate delivery, i.e., within
one day for US dollars and within two days for other convertible currencies),
done through any of these transaction vehicles.

When banks trade, either for their clients or for their own accounts, they
follow a set of guidelines laid by the BSP (Manual of Regulations on
Foreign Exchange Transactions, as amended; Circular 471 dated 24
January 2005; and other applicable BSP regulations) to ensure orderly
trades in the foreign exchange markets.

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7. How does one judge whether the exchange rate is at an appropriate

level or not?

One way of judging the appropriate level of the exchange rate is by looking
at the trend in the real effective exchange rate (REER) of the peso versus a
basket of currencies. This measure takes into account not only the nominal
exchange rate movements but also the relative inflation rates among trading
and competing countries. As such, the REER is a more comprehensive
measure of external price competitiveness.

On 26 March 2013, the BSP released three new indices which measure the
nominal and real effective exchange rates (EER) of the peso relative to the
currencies of the following groups of countries: 1) all major trading partners
(TPI) of the Philippines covering merchandise exports and imports;1 2)
trading partners in advanced countries (TPI-A);2 and 3) trading partners in
developing countries (TPI-D).3 The methodology used for calculating the
new indices was also revised as the BSP shifted from arithmetic to
geometric formulation and from base year to chained indices.

Starting 2014, the new indices replaced the old EER indices as the official
effective exchange rate indices of the BSP. The new peso EER indices
would enable BSP to gauge more objectively the overall movements in the
exchange rate of the peso across currencies. An increase in the indices
means an overall appreciation of the peso and a consequent loss in external
price competitiveness against the basket of currencies, while a decrease
translates to a real depreciation and a corresponding gain in external price
competitiveness.

8. How does one measure the volatility of the peso?

One way of measuring the volatility of the peso is through the coefficient of
variation (COV), which is the ratio of the standard deviation and the
average exchange rate of the peso for a given period. A low coefficient of
variation indicates a stable peso while a high coefficient of variation reflects
a volatile peso.

1
The Trading Partners Index (TPI) measures the nominal and real effective exchange rates of the peso across the
currencies of 14 major trading partners of the Philippines, which includes US, Euro Area, Japan, Australia, China,
Singapore, South Korea, Hong Kong, Malaysia, Taiwan, Indonesia, Saudi Arabia, United Arab Emirates, and Thailand.
The major trading partners of the Philippines are defined as trading partners which accounted for at least one percent
share of the total merchandise exports and imports of the Philippines for the past five years (2007-2011).
2
The TPI-Advanced measures the effective exchange rates of the peso across currencies of trading partners in
advanced countries comprising of the US, Japan, Euro Area, and Australia.
3
The TPI-Developing measures the effective exchange rates of the peso across 10 currencies of partner developing
countries which includes China, Singapore, South Korea, Hong Kong, Malaysia, Taiwan, Indonesia, Saudi Arabia,
United Arab Emirates, and Thailand.

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9. What measures are undertaken by the BSP to maintain order and

stability in the foreign exchange market?

The BSP uses three general tools to operationalize the exchange rate
policy, namely: 1) participation in the foreign exchange market; 2) monetary
policy measures; and 3) foreign exchange regulations.

The BSP participates by buying and selling foreign exchange in the foreign
exchange market to ensure order and temper destabilizing swings in the
exchange rate. It does not set out to reverse the underlying trend of the
peso, whether it is appreciating or depreciating; rather, its objective is to
smooth out volatility in the exchange rates. Assume that there is an
artificially strong demand for dollars which is causing the exchange rate to
weaken. The BSP can suppress speculation by selling dollars to moderate
the depreciating trend. If there is an artificially strong supply of dollars
relative to demand in the market, the BSP can soften the appreciation of the
peso by buying dollars.

If the exchange rate movement threatens to move inflation rate outside its
target range, the BSP also uses monetary policy measures, including
adjusting the key policy rates or the interest rates it charges for its borrowing
and lending activities. For example, in periods of weakening pressure on
the peso, increases in interest rates tend to dampen the demand for dollars.
As a result, the depreciation pressure on the peso eases. However, any
such interest rate action needs to be consistent with the price stability
objective of the BSP.

The BSP has also combined foreign exchange intervention and monetary
measures with market-based foreign exchange regulations to prevent major
exchange rate volatility. For example, during the recent episodes of strong
foreign exchange inflows, the BSP pursued liberalization of the country’s
existing foreign exchange regulatory framework, particularly those
pertaining to outward investments, foreign exchange swaps, capital
movements as well as banks’ foreign exchange positions. The reforms
allowed individuals and businesses greater access to foreign exchange for
outward investment and over-the-counter transactions. By making the FX
environment more open, some of the pressure on the exchange rate could
be alleviated.

RECENT DEVELOPMENTS IN THE EXCHANGE RATE

10. How has the exchange rate moved in the third quarter of 2018 and
what were the factors behind the movement?

The peso depreciated against the US dollar in Q3 2018. The peso

averaged ₱53.55/US$1 in Q3 2018, depreciating by 2.06 percent from the
previous quarter’s average of ₱52.45/US$1. The peso’s depreciation during

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the quarter was due mainly to concerns over the lingering trade tension
between the US and its major trading partners, including China. On a year-
on-year basis, the peso likewise depreciated by 5.06 percent relative to the
₱50.84/US$1 average in Q3 2017.4

In July, the peso averaged ₱53.43/US$1, depreciating by 0.72 percent from

the June average amid: (i) lingering trade war concerns (between the U.S.
and its major trading partners); (ii) the recent negative trade remarks by US
President Trump against the European Union (EU); and (iii) hawkish
remarks from US Fed Chairman Powell which strengthened the prospect of
a gradual rate hike path of the US Fed.5 The release of upbeat U.S.
personal consumption data for the month of May likewise added pressure to
the peso.6

The peso recovered in August as it appreciated by 0.30 percent to an

average of ₱53.27/US$1 from the average in July. The peso appreciated
amid: (i) market expectation of a third BSP rate hike during its monetary
policy meeting on 9 August; (ii) weaker-than-expected US non-farm payrolls
report for the month of July;7 and (iii) market optimism over news of trade
talks between the US and Mexico to overhaul the North American Free
Trade Agreement, with Canada expected to also agree to the new terms.

In September, the peso depreciated anew to an average of ₱53.94/US$1

declining by 1.24 percent from the average in August due mainly to: (i)
market concerns over continued trade tension between the United States
(U.S.) and China; and (ii) expectation of a US Fed rate hike in its 25-26
September meeting; and on the domestic side, (iii) wider-than-expected
trade deficit in July;8 and strong corporate demand for US dollar, particularly
from oil and power companies.

On a year-to-date basis, the peso depreciated against the US dollar by

7.57 percent to close at ₱54.02/US$1 on 28 September 2018 from the end-
December 2017 closing rate of ₱49.93/US$1. The peso depreciated along
with other regional currencies except the Thai Baht.9

4
Dollar rates (per peso) or the reciprocal of the peso-dollar rates were used to compute for the percentage change.
5
According to BusinessWorld, US President Trump said in an interview with CBS aired on 15 July 2018 that the EU is a
“foe” of the United States for what the European bloc does to the US in terms of trade. Meanwhile, Reuters reported
US Fed Chair Powell said before the Senate Banking Committee on 17 July 2018 that he sees the US on track for years
of steady growth amid strong job market and steady inflation.
6
Reuters reported that the personal consumption expenditures (PCE) price index in the U.S. increased to 2.3 percent
in the 12 months through May, its biggest gain since March 2012. Meanwhile, core PCE price index reached 2.0
percent, the biggest gain since April 2012. The core PCE index is the U.S. Fed’s preferred inflation measure.
7
BusinessWorld reported that the US’ additional jobs produced in July 157,000 was the slowest gain since March and
lower than the market expectation of 190,000 jobs (Reuters poll).
8
Data from the Philippine Statistics Authority (PSA) show that the country’s balance of trade in goods, stood at a
$3.55 billion deficit in July as imports accelerated while exports grew relatively flat.
9
Based on the last done deal transaction in the afternoon.

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11. How did the peso behave on a real trade–weighted basis?

On a real trade-weighted basis, the peso gained external price

competitiveness in the Q3 2018 against the basket of currencies of all
trading partners (TPI), trading partners in advanced (TPI-A) and trading
partners in developing (TPI-D) countries relative to Q2 2018, as the real
effective exchange rate (REER) index of the peso decreased by 1.4
percent, 1.0 percent and 1.7 percent against the TPI, TPI-A and TPI-D
baskets, respectively. Overall, the general decrease in the REER index was
due mainly to nominal depreciation of the peso during the said months
compared to Q2 2018.10,11

Relative to Q3 2017, the peso likewise gained external price

competitiveness in Q3 2018 across currency baskets. This developed as the
nominal depreciation of the peso offset the impact of positive inflation
differential, resulting in the decrease in the REER index of the peso by 4.3
percent, 6.6 percent, and 2.5 percent against the TPI, TPI-A and TPI-D
baskets, respectively.

12. Has the peso been volatile?

The volatility of the peso’s daily closing rates (as measured by the
coefficient of variation) stood at 0.65 percent during the review quarter,
lower than the 1.05 percent registered in the previous quarter.12 The
volatility of the peso was lower than most of the other currencies in the
region.

13. What is the medium-term outlook on the peso?

Over the policy horizon, the peso is expected to be broadly stable and
reasonably flexible to reflect changing demand and supply conditions in the
foreign exchange market. The expected growth in foreign exchange inflows
from overseas Filipino remittances and BPO revenues in 2018 by 4.0
percent and 10.0 percent, respectively; and the recent Fitch Ratings’
affirmation of the Philippines’ investment grade score of “BBB“13 are
10
The TPI measures the nominal and real effective exchange rates of the peso across the currencies of 14 major
trading partners of the Philippines, which includes US, Euro Area, Japan, Australia, China, Singapore, South Korea,
Hong Kong, Malaysia, Taiwan, Indonesia, Saudi Arabia, United Arab Emirates, and Thailand. The TPI-A measures the
effective exchange rates of the peso across currencies of trading partners in advanced countries comprising of the US,
Japan, Euro Area, and Australia. The TPI-D measures the effective exchange rates of the peso across 10 currencies of
partner developing countries which includes China, Singapore, South Korea, Hong Kong, Malaysia, Taiwan, Indonesia,
Saudi Arabia, United Arab Emirates, and Thailand.
11
The REER index represents the Nominal Effective Exchange Rate (NEER) index of the peso, adjusted for inflation
rate differentials with the countries whose currencies comprise the NEER index basket. A decrease in the REER index
indicates some gain in the external price competitiveness of the peso, while a significant increase indicates the
opposite. The NEER index, meanwhile, represents the weighted average exchange rate of the peso vis-à-vis a basket
of foreign currencies.
12
The coefficient of variation is computed as the standard deviation of the daily closing exchange rate divided by the
average exchange rates for the period.
13
On 17 July 2018.

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expected to provide support to the peso. Likewise, the sustained inflows

from foreign direct investments, tourism receipts, the ample level of the
country’s gross international reserves and the country’s robust economic
growth could continue to provide stability to the peso. The credit rating
upgrades that have been earned over the last few years are expected to
sustain market confidence towards the Philippine financial markets.

Over the medium term, the peso, however, may also reflect external
developments that likewise affect local market sentiments. These include:
i) shift towards protectionism; ii) faster than expected rise in US policy rates;
iii) aggressive rollback in financial regulations in the US; iv) faster credit
growth in China; v) weak demand, low inflation, weak balance sheet in AEs;
and vi) non-economic factors such as various global geopolitical tensions.
Nonetheless, the peso is still expected to remain broadly stable on account
of the country’s firm macroeconomic fundamentals—including robust GDP
growth, manageable inflation environment, favorable external payments
position, strong and resilient banking system, and prudent fiscal position.

Moving forward, the movement of the peso will remain market-driven.

Allowing market forces to determine the level of the peso has the following
benefits: (i) a flexible peso is consistent with the BSP’s inflation targeting
(IT) framework; and (ii) a flexible peso acts as an automatic stabilizer to
restore macroeconomic balance for a small open economy like the
Philippines.

POLICY RESPONSES BY THE BSP

14. What were the recent foreign exchange measures undertaken by the
BSP?
FX Rules Feb  To maintain a safe and sound financial system and a
Further 2016 stable FX market, the Monetary Board (MB) approved
Liberalized further liberalization of the rules governing FX
transactions in the Philippines. The amendments
include:
o Prior BSP approval is no longer required for the
borrowings from offshore sources/FCDUs of banks
of the following resident entities:
 Purely private sector loans (i.e., without
guarantee from the public sector or banks) that
are intended to finance energy-/power-related
projects; and
 Private non-bank financial institutions engaged
in microfinance activities where loan proceeds
will be used for microfinance lending.
o Allowing the conversion to FX of pesos arising from
disapproved subscriptions of non-resident investors
to stock rights offering of companies listed at the
Philippine Stock Exchange.
 Other procedural/clarificatory amendments to the

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Manual of Regulations on Foreign Exchange

Transactions were also approved for better guidance of
users.

FX Rules Jul As part of continuing efforts to keep regulations

relaxed/ 2016 appropriate for the changing needs of the Philippine
liberalized economy and following the thrust towards greater
anew openness in view of the country’s increasing
integration with global markets, the MB further
liberalized existing regulations governing transactions
in FX effective 15 September 2016:
o Increased the amount of FX that Philippine
residents may purchase from the banking system
without supporting documentation (other than an
application to purchase FX) for legitimate
transactions from US$120,000 to US$500,000 (for
individuals) and US$1 million (for corporates). This
is to enhance and further facilitate access to FX of
both individuals and corporates for legitimate non-
trade current account transactions.
o Allowed the deposit by Philippine residents of FX
purchased from banks for certain underlying
transactions (such as for travel abroad and
payment of certain obligations to non-residents)
into their Foreign Currency Deposit Unit (FCDU)
accounts, prior to outward remittance to the
intended non-resident beneficiaries. This is to
provide residents with greater flexibility in
managing their cash flows as well as provide
greater ease in transacting in FX.
o Lifted the prohibition on the sale of FX by banks
and their forex corporations for resident-to-resident
transactions. This is to facilitate payment by
residents of obligations to their resident
counterparties and allow further diversification of
residents’ investments.
o Lifted prior BSP approval and registration
requirements for private sector loans to be
obtained from FCDUs/Expanded FCDUs of banks.
This is in line with the BSP’s thrust to facilitate
access of the private sector to bank financing.
o Increased the amount of Philippine currency that
may be brought into/out of the country from
P10,000 to P50,000. This is to provide greater
convenience to travelers to and from the
Philippines, and allow settlement of obligations in
jurisdictions outside the Philippines where the
Philippine Peso is accepted as a currency of
settlement.

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Further
Sep  The BSP eased rules on foreign exchange flows anew
2016 to facilitate entry of significant amounts for foreign
Amendments
to Foreign banks in the country as they move to meet capital
Exchange requirements. This is intended to align regulations
(FX) with the provisions of R.A. No. 10641, which allowed
Regulations the full entry of foreign banks and BSP Circular No.
858 dated 21 November 2014.
 The approved policy changes mainly involve: (a)
inclusion of an express provision that the FX funding
for permanently assigned capital of foreign bank
branches must be inwardly remitted and converted to
pesos at the exchange rate prevailing at the time of
remittance, pursuant to the pertinent provisions of the
Manual of Regulations for Banks (MORB); (b) use of a
general reference to the MORB instead of citing R.A.
Nos. 7721 and 10641 or the specific provisions of the
MORB; and (c) revision of the definitions of
“unimpaired capital of a local bank”, “unimpaired
capital of foreign bank branches” and “unimpaired
capital of foreign bank subsidiaries” as contained in
the MORB.

Dec  Lifted prior BSP approval requirement for private

2017 sector foreign loans as well as foreign currency-
denominated loans/borrowings from onshore banks
(including those in the form of bonds/notes/other debt
instruments issued offshore) that are not guaranteed
by the public sector. These borrowings will be subject
to registration only if these will be serviced with FX to
be purchased from the banking system.
 Streamlined and simplified documentary requirements
for applications for: (i) approval of public sector
foreign/foreign currency loans; and (ii)
approval/registration of private sector foreign/foreign
currency loans.
 Replaced the positive list of costs/projects that may
be funded with foreign/foreign currency loans with a
general policy statement (i.e., the purpose must be
legitimate, and not contrary to laws, regulations,
public order, public health, public safety, or public
policy).
o Lifted BSP registration for private sector, provided
these are duly reported to the BSP:
 loans that are not guaranteed by foreign
governments/official export credit agencies
covering importation of freely importable
commodities under deferred L/Cs or D/A-O/A
arrangements with a term of more than one (1)
year; and
 short-term loans in the form of export advances
from buyers abroad.

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 Lifted the $60,000.00 daily limit on FX sale by

depository banks (AABs) for the balance of peso
deposit accounts of non-residents.
 Opened temporary window for registration of private
sector foreign/foreign currency loans. The temporary
window was opened for six months to allow BSP
registration of the accounts and servicing of the
outstanding balances on scheduled due dates using
FX resources of the banking system. Previously,
these loans can only be settled with the borrower’s
own FX or with funds sourced outside the banking
system.
May
2018  Lifted prior BSP approval on: (a) conversion of foreign
currency loans granted by banks to peso loans; and
(b) transfer of such loans, as well as Real and Other
Properties Acquired from banks’ foreign currency
deposit unit books to the Regular Banking Unit books.
Prior BSP approval under certain conditions on the
aforementioned transactions was originally put in
place to ensure that banks fully understand the nature
and extent of the risks involved. The conditions also
ensure that banks have put in place appropriate
business policies and risk management systems to
manage these transactions.

Currency  The BSP, on 5 October 2018, issued Circular No.

Oct 1015, which outlines the enhanced guidelines of the
Rate Risk
Protection
2018 “Currency Rate Risk Protection Program (CRPP)
Program Facility,” which was first implemented at the wake of
(CRPP) the 1997 Asian Financial Crisis.
 The CRPP is a non-deliverable forward (NDF)
contract between the BSP and a universal/commercial
bank (UKB) in response to the request of bank clients
who are seeking to hedge their borrowings
denominated in foreign currency to protect them from
exchange rate volatility. Under this facility, parties
agree that, on maturity of the forward contract, only
the net difference between the contracted forward rate
and the prevailing spot rate shall be settled in pesos.
 Under this facility, the eligible obligations are
unhedged foreign currency obligations in amounts of
not less than US$50,000.00 that are current and
outstanding as of the date of application, including:
a) BSP-reported/registered short-term (ST) trade-
related loans from eligible banks;
b) BSP-reported medium/long-term trade-related
FCDU/RBU loans with payments maturing within
90 days as of date of application;
c) BSP-reported/registered short-term trade-related

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borrowings of oil companies from offshore banking

units (OBUs); and
d) US dollar trust receipts, among others.

Maximum tenor is 90 days with option to re-avail.

The following are some of the regulatory relief

encompassed in the CRRP facility:
a) Exposures under the CRPP facility shall not be
subject to NDF position limits;
b) Reduced market risk capital charges shall be
applied for net open positions for NDFs under this
facility; and
c) UKBs will not need additional derivatives authority
since transactions under the CRPP are
considered generally authorized derivatives
activities.

ISSUES ON FOREIGN EXCHANGE

15. Why did the BSP adopt a floating rate system?

The floating exchange rate system was adopted in 1970 because the
government considered that occasional, large fluctuations—typical of the
fixed exchange rate system—are more costly, destabilizing and disruptive
to the economy than the more frequent but more gradual changes that may
occur in a free float.

The floating rate system is consistent with the current regime's national
strategy of achieving external competitiveness through efficiency, which is
also a central theme of the foreign exchange liberalization efforts. In terms
of exchange rate policy, such efficiency is injected into the economy by
basically leaving exchange rate determination to the market forces of
supply and demand.

16. Why not fix the exchange rate? Or adopt a dual or multiple exchange
rate system?

Under a system of fixed exchange rate, the central bank commits to sell or
buy any amount of foreign currency demanded in excess of what can be
supplied by the market or offered for sale in excess of what is demanded, to
keep the official exchange rate at a certain level.

For a small open economy such as the Philippines, large capital flows can
occur at any time. In times of massive dollar inflows, the monetary
authorities must buy the excess dollars to keep the foreign exchange at the
desired level. In so doing, reserves are accumulated but pesos are released

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into the system from which inflationary pressures could result. Siphoning off
excess pesos for example (through the sale of government securities in the
BSP's portfolio) could entail substantial cost to the BSP in terms of the
difference between the cost of borrowing to pay for the dollar purchases
and the return to the BSP on the foreign exchange purchases. Apart from
the fiscal costs of sterilization, the sale of government securities is likely to
push up interest rates and attract additional foreign capital inflows into the
economy.

On the other hand, in times of massive dollar outflows, monetary authorities

must sell dollars to accommodate any excess demand. In so doing,
reserves are drawn down. If the massive outflow is sustained, reserves will
diminish. Before this happens, the central bank is forced to reset the official
exchange rate, often opening itself to exchange losses. Thus, fixing the
exchange rate places a heavy burden on monetary authorities in terms of
reserve and liquidity management.

A dual or multiple exchange rate system is discriminatory and distorts

resource allocation. If the government sets a high rate for exporters and
OFs, it will have to subsidize the difference between market rates and the
fixed higher rate. However, this is not feasible since government revenues
are not yet sufficient to cover our annual budget. On the other hand, private
banks will not be willing to do this as it will incur losses in the process of
paying higher than prevailing market exchange rates.

17. Is the current exchange rate policy in line with the inflation targeting
approach to monetary policy?

The BSP’s adherence to a flexible or a market-determined exchange rate

system anchors its commitment to its constitutional mandate to maintain
price stability.

It is also consistent with the inflation targeting (IT) framework for monetary
policy which demands disciplined commitment to participate in the foreign
exchange market only in well-defined circumstances, such as when there is
a need to smooth out exchange rate volatility which can threaten our
inflation target. The BSP’s participation in the foreign exchange market
during such a situation is compatible with price stabilization since
fluctuations in the exchange rate tend to feed directly into domestic prices of
imported goods and services, and indirectly, through the prices of goods
and services that use imported inputs. The increase in prices of both the
imported and import-intensive goods, in turn, leads to demands for wage
hikes and transport fare adjustments, among other things. Through this
channel, exchange rate movements affect both the actual inflation and
inflation expectations.

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18. Why can't the BSP intervene more heavily during periods of high peso
volatility?

Heavy intervention cannot be sustained for a long period of time because it

could create problems for monetary policy.

To sterilize intervention and mop up excess liquidity, the central bank would
have to either raise policy rates and/or undertake open market operations.
These policy actions may not be sustainable because they are costly to
central banks.
 High interest rates required to siphon off liquidity would give countries
with fiscal difficulties and/or weak macroeconomic conditions very little
room to maneuver.
 Moreover, raising interest rates is likely to result in a further increase in
foreign capital inflows which may necessitate more sterilization, resulting
in a vicious cycle.
On the other hand, unsterilized interventions may lead to unwarranted
monetary expansion and generate upward pressure on prices. This runs
counter to a central bank’s mandate to maintain price stability.

19. What is the view of the BSP regarding the imposition of capital
controls?

Imposing strict capital controls poses more costs than benefits.

 First, there are administrative difficulties that must be hurdled to
implement effectively these restrictions. The tax on international
transactions should be universally implemented to prevent the creation
of tax arbitrage opportunities. Some difficulties in implementing the tax
could also arise due to advances in technology and the growing
sophistication of financial instruments, which allow investors to
circumvent controls and/or taxation.
 Second, the imposition of controls hampers the efficient allocation of
capital across countries.
 Finally, the re-imposition of controls would send negative signals to
investors and adversely affect our access to international capital markets
and our ability to attract foreign investments.

20. What are the advantages and disadvantages of a firm peso?

On the one hand, a firm peso confers benefits to the economy—the

consumers in general (by tempering the general rise in the prices of goods
and services or inflation arising from increases in international prices of
imported or import-based commodities), importers, Filipinos who travel or

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invest abroad, and those who pay for foreign loans (including the
government). Overall, a firm peso:
 Helps dampen inflationary pressures;
 Translates to lower debt servicing;
 Enables the BSP to build up international reserves; and
 Allows prepayment of foreign exchange obligations.

On the other hand, a firm peso could have some negative impact on certain
sectors, including some export-oriented companies, domestic producers of
import substitutes, tourism sector, foreign investors, and creditors who had
lent money in foreign currency, and overseas Filipinos and their families.

21. What are the advantages and disadvantages of peso depreciation?

A weak peso can improve the external price competitiveness of Philippine

products, thereby increasing the country’s export earnings. The peso
equivalent of OF remittances in foreign currencies will also increase as the
peso depreciation will mean more pesos in exchange of one foreign
currency unit (e.g., US$1). Moreover, tourism and investment activities will
increase as it will be less costly and more desirable for foreigners to travel
and invest in the Philippines.

However, peso depreciation can also increase inflationary pressures as it

would cost more pesos to buy imported products and raw materials such as
oil and rice.

22. What is the impact of “currency wars” on global financial markets?

What have been the policy responses?

“Currency wars” refer to competitive currency devaluations among

countries. An example of this is the situation in which substantial monetary
policy easing in many of the major advanced countries to support their
economies has fueled a downward slide in the value of their currencies,
while emerging economies (including many Asian countries) attempt to
arrest the appreciation of their own currencies (e.g., against the US dollar)
through a variety of measures.

Policy responses by emerging economies to cope with the risks brought

about by large and destabilizing capital inflows have included exchange
rate appreciation, macroprudential measures and tighter fiscal policy.
However, there are significant cross-country differences in the extent of
exchange rate flexibility and the scope for policy responses in some
countries receiving large inflows.

Competitive currency devaluations are a “beggar-thy-neighbor” policy that

can ultimately destabilize the still weak global recovery. A sharp
depreciation in the value of a major currency could result in the adoption of

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protectionist policies by other countries in response. This could destabilize

global financial markets, pulling asset values away from fundamentals, and
eventually hurt businesses and households worldwide.

23. Is there a possibility for the establishment of a single Association of

Southeast Asian Nations (ASEAN) currency?

Integration within the Asian region has been progressing significantly in

recent years. This may be observed from the rise in intra-regional trade and
flows of investments within the region. There are also a number of initiatives
which support the greater linkage between economies. These initiatives
include the establishment of free trade agreements, the Chiang Mai
Initiative Multilateralization and various efforts to develop the regional bond
market.

Amidst these initiatives, there is also a discussion on the possibility of the

region adopting a single currency and eventually forming a monetary union
with one central bank for the region. This issue has been examined by
economic authorities in the region and it has been found that the ASEAN is
not ready yet to adopt a common currency in the near future. This is due to
lack of macroeconomic convergence, inadequate regional institutional
framework, low intra-regional trade and concerns over the potential loss of
sovereignty over national policymaking. Furthermore, more than the
economic prerequisites, the formation of a common currency area requires
political will and social consensus. At present, these factors need to be
strengthened. The policymakers in the region are focusing instead on
deepening integration through trade liberalization and financial market
developments. While the adoption of a single currency may be difficult in
the near to medium term, its eventual emergence cannot be discounted.

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