Fed tightening expected to weaken peso

THE PHILIPPINE peso will likely be “stirred” but “not shaken” once the US Federal Reserve starts raising key interest rates and causing foreign exchange volatility in emerging markets, economists from Ayala-led Bank of the Philippine Islands said.

With its ample foreign exchange reserves, the Philippines is one of the least vulnerable in the emerging markets space, BPI economists Emilio Neri Jr., Nicholas Mapa and Robbin Ivory Brillantes said in a research note.

BPI sees the peso depreciating by this yearend to 46.50 against the US dollar and further to 47.50 versus the greenback by end-2017. On Friday, the peso closed at 45.125 to $1.

The economists have also priced in a 50-basis point hike in special deposit account (SDA) and overnight rates this year and another 50 basis points next year.

For this year, BPI expects the country’s gross domestic product to expand by 6.5 percent and by another 6.7 percent next year.

“Despite improved fundamentals, contagion among emerging markets will ensue and the Philippine peso will likely be dragged along with the rest of the region and asset class,” the research note said.

Reversal of funds in reaction to the US Fed lift-off may spark exchange market pressure on the peso, forcing it to a more comfortable and competitive position in the middle of the Association of Southeast Asian Nations pack, the research note said.

“Currently, the Philippines has one of the highest (coverage) ratios in the emerging markets space, which will be a boon when Fed policy normalization is seen to cause market volatility,” the research said.

“There is a need, however, to maintain competitiveness in the Asean space as exports, and now the BPO (business process outsourcing) sector, have become more integral to our economy,” the research note said.

The economists said financial market volatility could not be avoided as funds would likely shift back to the US once it starts hiking interest rates this year. “Fund managers do not necessarily hold on to assets with good fundamentals. They make profit on good assets to make some gains and therefore compensate for losses in assets with bad fundamentals,” the research said.

The BPI research said that even if the Philippines had good foreign exchange reserves to debt coverage, sizeable or unhedged or currency mismatched borrowing could trigger exchange market pressure. Nevertheless, it said the peso would only likely be “very mildly affected.”

But the research noted that compared to its regional peers, the Philippines had the biggest unhedged exposure relative to the size of the entire foreign exchange liabilities of the economy. It estimated that the total external obligations were about 2.5 times as big as a year’s worth of core or non-electronic exports.