The losers in the weakening of the peso, rising rates

The announcement of a significantly higher than expected inflation of 6.4 percent for the month of August and the wider than expected trade deficit of $3.5 billion for the month of July acted as the catalyst for the peso to depreciate to P53.98 against the dollar from P53.475 in two weeks. Worrisome, too, is the sharp increase in the 10-year bond rate to 7.03 percent from 6.5 percent during the same period.

It doesn’t help that other emerging market currencies and bonds are also weak and out of favor. All these factors combined, the Philippine Stock Exchange index (PSEi) made an almost six-percentage point drop to 7,413.15 from its most recent high as investor sentiment turned negative.

The weak peso and higher interest rates are not good for the stock market. These factors hurt the profitability of many listed companies by increasing the cost of imported raw materials and the cost of borrowing.  Higher interest rates are also causing funds to shift away from stocks to fixed income instruments, which now provide higher yields.

Among the various sectors, we think the following are most vulnerable to the weak peso, rising interest rates, or both, in the short-term.

Banks: Aside from weaker trading gains, the significant increase in interest rates in the short term also makes banks vulnerable to higher funding cost as system loans to deposit ratio is already at 75.6 percent as of end-June. The BSP’s move to cut reserve requirements by 200 basis points earlier this year provided some relief as it released around P180 billion worth of deposits for lending without pushing up banks’ funding costs. However, the BSP temporarily suspended the reduction in bank reserve requirements because of high inflation. Higher funding cost will hurt banks’ margins and could soften loan demand assuming that banks pass on higher rates.

Property companies: A large number of buyers rely on mortgages or debts to purchase properties. However, the significant increase in interest rates in the short term will lead to a sharp rise in the size of monthly amortizations on housing loans, making purchases of properties less affordable. This, in turn, is expected to hurt demand for properties.

Restaurants and manufacturers: Most restaurants and manufacturers are largely dependent on imported raw materials, thus making them vulnerable to a weak peso. Margins and profits could go down assuming that these companies fail to pass on the higher costs through price increases. There is also a risk of sales volumes dropping assuming that companies increase their selling price.

Airlines: Airlines are highly vulnerable to the weak peso since oil accounts for a large portion of total costs. Airlines are also highly vulnerable to rising interest rates since planes are bought using borrowed funds. Although they can increase plane fares, demand could be negatively affected.

Aside from these, a company that has a lot of debt—especially one that has a dollar-denominated debt but does not have dollar-denominated revenues—is highly vulnerable to rising rates and the weak peso.

I would like to emphasize though that the outlook for banks, property companies, restaurants, manufacturers and airlines is only for the short term. Once the government successfully addresses the problem of inflation, the peso should stabilize and interest rates should go down, improving the outlook of the said sectors again. Ironically, the government’s infrastructure spending program, which is responsible for the surge in imports and is partly responsible for higher inflation this year, should also help address the same problem over the long term as it eases supply bottlenecks on a more permanent basis.