FEATURE

BSP rolls up its sleeves as hot money pours in

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WHILE the global economy struggled through 2012 due to the prolonged crisis in the euro zone and the fiscal problems of the United States, the Philippines appeared like it just came from a refreshing walk  in the park.

The domestic economy boasted of a 6.5-percent growth in the first three quarters while inflation was kept at bay. These developments led some people to believe that the emerging market was totally unaffected by events offshore.

But the Bangko Sentral ng Pilipinas said that, in 2012, the country had its own share of difficulties as far as dealing with the consequences of a weak global economy was concerned.

“Global developments did spill over to the Philippines, not in the form of slower economic growth … [but in] surges in capital flows to the economy,” BSP Governor Amando Tetangco told members of the Rotary Club of Manila last Jan. 3.

Because advanced economies were struggling, portfolio fund owners worldwide looked for other places to park their cash. The Philippines, along with other emerging markets, caught their attention because of the robust economic growth and promising outlook over medium term.

Gross inflows of foreign portfolio investments hit $16.72 billion in the first 11 months of 2012, rising by over 8 percent from the $15.43 billion reportyed in the same period the previous year, data from the central bank showed.

For the BSP, foreign “hot money” is welcome for it helps make the country’s capital market vibrant.

But monetary authority are also concerned, treating the entry of more foreign capital with caution. This is because excessive and speculative portfolio investments have a tendency to disrupt the performance of any economy.

In particular, any sudden rise in foreign capital flows may cause the peso to sharply appreciate. A strong peso makes Philippine-made goods more expensive to foreigners, reducing the competitiveness and income of Filipino exporters. It also reduces the value of the dollar remitted by overseas Filipino workers, affecting the income of recipient households.

Because of substantial foreign exchange inflows, the peso became the second fastest appreciating Asian currency in 2012. It closed at 41.05 against the US dollar on the last trading day of the year, rising by nearly 7 percent from 43.86 at the start of 2012.

Managing capital flows

To deal with the capital flows, the BSP implemented several measures in 2012.

One was the imposition of a higher capital charge on banks’ holdings of non-deliverable forwards (NDFs). From 10 percent, the capital-cover requirement for banks’ NDF exposure was raised to 15 percent.

NDFs are hedging instruments meant to protect importers and exporters from volatilities in the exchange rate. But policymakers believe these instruments are also being used by some banks and their clients to earn from currency speculation.

Another move was the reissuance of an old regulation prohibiting banks from investing money of foreigners in special deposit accounts with the BSP.

Because SDAs carry interest rates higher than yields from regular bank deposits, the former are considered to be attractive venues where institutions can park their excess cash. But with the prohibition on placement of foreign funds in SDAs, the BSP believes that the surge in foreign capital flows will be tempered.

Another move by the BSP was its dollar purchases.

Diwa Guinigundo, BSP deputy governor and head of the monetary policy division, said that the central bank maintains a policy of allowing the market to determine the peso’s exchange rate. It will only intervene when the currency fluctuates sharply.

“We see the threat of capital flows. The BSP will continue to use measures from its policy toolkit in dealing with these flows, which normally increase levels of liquidity and create spillover effects to asset markets,” Guinigundo said in a recent press conference.

He said participation in the foreign-exchange market in the presence of extreme volatility threats is one of the strategies of the BSP to maintain stability in the financial markets and in the economy in general.

The BSP believes that its policy against extreme volatility of the peso helps curb betting by currency speculators.

Huge costs

The heavy dollar purchases by the BSP led to the buildup of the country’s gross international reserves. The GIR, the accumulated amount of foreign exchange, reached a record high of $84.25 billion by the end of 2012.

The increase in the GIR helped boost the country’s creditworthiness. Growth in the GIR, which means the country has become more able to service its debts to foreign creditors, was often cited as one of the reason why the Philippines enjoyed upgrades in its credit ratings over the past two years.

However, the heavy dollar purchases by the BSP that led to the buildup of the country’s GIR did not come without a cost—and the cost was huge.

Boosting the BSP’s expenditures, the dollar buying caused the central bank to incur a net loss of P68 billion in the first three quarters of 2012.

Losses by the BSP was not left unnoticed, especially by some legislators who  once in a while would raise the issue in Congressional hearings.

The BSP would often respond by saying losses incurred from foreign-exchange operations are a natural consequence of its keeping up with the responsibility of helping keep financial markets and the economy stable.

“We need to maintain stability in the system, and so we need to absorb some inflows,” Tetangco said. “The maintenance of monetary stability is an important objective for us, and so we will continue to pursue that objective,” he added.

2013 outlook

There is a consensus among policymakers and capital-market participants that appreciation pressures on the peso may persist in 2013. Favorable developments in the economy expected this year will cause more portfolio fund owners worldwide to buy peso-denominated securities, they said.

This year, the Philippines is expected to get an investment grade. All major international credit watchdogs—Fitch Ratings, Moody’s Investors Service, and Standard & Poor’s—now rate the country just one notch below investment grade.

Should the Philippines be able to sustain trends of improving macroeconomic indicators, economists said, the credit watchdogs will finally be convinced that the country deserves the elusive investment grade in 2013.

“With investment-grade status just around the corner, we could continue to see more foreign capital come into our domestic financial markets,” Tetangco said.

What this means for the country’s capital markets is that demand for peso-denominated securities could remain high. In other words, the Philippine Stock Exchange Index could continue to break records, and interest rates on Treasury bills and other fixed-income securities could continue to remain very low.

But what this means for the BSP is that its skills in management of capital inflows must remain up to task. It also means that measures addressing the adverse effects of excessive capital flows must be in place.

Additional measures

Despite the several measures implemented in 2012 to address capital flows, the BSP said more are about to come. This is especially so if projections of another surge in foreign capital flows would materialize.

At the start of 2013, the BSP implemented a regulation imposing a ceiling on NDF exposure of banks. In particular, domestic banks are now required to limit their exposure to NDFs to an amount equal to 20 percent of their capital, and foreign banks must limit theirs to an amount equal to 100 percent of their capital.

Tetangco said the BSP will closely monitor the financial markets and update its policies from time to time and as necessary.

“We will continue to review our policy settings and see if there is a need to put in place other macro-prudential measures to ensure price and financial stability,” he said.

The BSP chief said managing capital flows and keeping financial markets well behaved are indispensable at helping ensure the Philippines—which became one of the fastest-growing economies in Asia last year—does not veer away from the path of a sustainable economic growth.

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  • Hayek_sa_Maynila

    “Diwa Guinigundo, BSP deputy governor and head of the monetary policy division, said that the central bank maintains a policy of allowing the market to determine the peso’s exchange rate. It will only intervene when the currency fluctuates sharply.”

    This was the policy framework of the BSP since 1993 and it has failed us several times. It encourages dangerous one way bets on USD/PHP and heavy USD borrowings by PHL corporates whenever global interest rates fall and carry trades take advantage of widening interest differentials.

    Its time the BSP revisits this policy framework to avoid making the same mistakes we made in the past. It should be anchored on a number of other things like the level of income-per-capita – in PHP terms, how much GIR we should hold to minimize the impact of sudden stops of capital flows in 1997 and 2008, how much foreign currency leverage PHL corporates and financial institutions are making, etc…

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