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Tuesday, October 9, 2012

Is $81.9-billion GIR excessive?

DEMAND AND SUPPLY
By Boo Chanco

According to the BSP release last Friday afternoon, preliminary data showed the country’s gross international reserves (GIR) reached $81.9 billion as of end-September. This GIR level, according to the BSP, could adequately cover 11.8 months worth of imports of goods and payments of services.
That’s a whole year’s worth of cover even as three months worth is often considered adequate. This current level is also equivalent to 11.7 times the country’s short-term external debt based on original maturity and 6.5 times based on residual maturity.
The flow of dollars into the Philippine economy has accelerated in recent months with increased OFW remittances, stronger growth of our BPO sector and bullish investor sentiment that has caused “hot money” to flow into our stock market. The PSE Index has been breaking record highs. The index reached another record high of 5,443.74 points last Thursday, causing Malacañang to issue a self congratulatory statement about it.
The strong dollar flow into our reserves has caused many local and foreign economists to voice some concerns. A Citibank economist, Johanna Chua, called this GIR level “excessive and costly”. According Chua, chief economist for Asia Pacific at Citi, the Philippines may already be the second-highest in the region, following China’s, particularly in terms of proportion to certain foreign liabilities of the country.
It is understandable why such an accumulation of reserves had been seen as something positive. ASEAN countries that were hard hit by the financial crisis in the late 90s have learned the value of ample reserves to serve as buffer in bad times. With the fires of global recession still raging unabated, central banks in the region including our own don’t seem to think there is anything wrong with being more than a little more cautious. “Excessive” is merely in the eyes of the beholder.
But economists are saying excessive foreign-exchange accumulation entails heavy costs and having more than enough is imprudent. Indeed, the BSP is losing a substantial amount of money as it shells out pesos to buy dollars in an effort to arrest the rapid strengthening of the peso, something the exporters, BPO investors and OFW families are already complaining about.
In buying the dollars, the BSP infuses additional peso liquidity into the economy which it now tries to sterilize by accepting ever higher amounts of peso deposits from banks and paying more on interest payments for the so called SDA accounts.
The problem with BSP sterilizing the excess liquidity is, as one economist puts it “it has, inadvertently but effectively, mobilized our unused savings to lend to a rich country at a low interest rate (say two percent) while paying the local banks a higher interest of about four percent, resulting in a negative carry for the BSP and a loss of more than P30 billion a year.”
The alternative is to do nothing and just let the additional pesos in the economy trigger a faster rise in inflation.
When BSP Governor Say Tetangco spoke before the Financial Executives of the Philippines (FINEX) last Friday, he acknowledged these concerns. “The peso appreciation has been recent topic of interest in news columns of academics and former government technocrats. A few have encouraged the BSP to ‘print more money’ instead of sterilizing, as a response to capital inflows. They would like the BSP to be more “resolute in our pushback” on the exchange rate lest we lose more jobs to competitor countries like India.”
But Tetangco is not convinced he needs to do more than what he is already doing. He is focused on the one responsibility of the BSP to control inflation. “The BSP’s primary mandate is price stability. It’s noteworthy that since 2009, the BSP has been successful at keeping inflation well-within the Government’s official target range. And it appears that we would be able to do the same in 2012 and 2013.
“Our forecast for inflation is that over the policy horizon, inflation should be manageable. Therefore our current policy stance remains appropriate. In other words, you can expect interest rates to remain low over this period. But we will make adjustments should circumstances warrant, including, among others, in the event tensions in the Middle East escalate and more weather-related supply chain disruptions occur.”
Dismissing suggestions to “print money”, Tetangco said such an approach as a means “to absorb the expected capital flows would lead to a tremendous expansion in domestic liquidity that would fan price pressures.”
Tetangco also believes that “the peso’s strength is largely fundamentally supported. So, official BSP action should only be to reduce excessive volatility in the rate movements.” Tetangco insists “the peso has maintained its competitiveness and volatility has just been in line with the region.”
Tetangco warns that “capital flows are fickle and crafting monetary policy to address them is even trickier.  It seems quite simple to prescribe monetary easing. But that seemingly simple construct could fan inflation pressures, lead to asset bubbles and create more ‘problems’ beyond what we thought we were trying to solve to begin with. It is easy to let money lose, but it is not easy to ‘clean up’ afterwards.”
On the “excessive” GIR, Tetangco explains that the BSP toolkit “also includes a careful build-up of our reserves. Reserves are for insurance. But it is not easy to determine an ‘optimal level’ as some have suggested. The risks we are now insuring against are also evolving.”
But a number of prominent local economists think our excess reserves can be used for better purposes than lending all that money cheaply to the US government (since the forex purchased by the central bank must be invested in very safe foreign assets). There have been suggestions to invest in higher yielding but riskier assets the way some countries have done by organizing so called sovereign wealth funds.
There were also suggestions to find a way to monetize some portion of the BSP’s GIR for infrastructure. But an economist pointed out that the 1993 BSP charter has reduced any “developmental” dimension in BSP’s mission (given the role of the previous Central Bank in fiscal support and development which led to its non-performing assets). The “economic growth” target is not emphasized in the BSP’s charter, in contrast to the US Federal Reserve which is responsible for both monetary stability and employment. 
Having a sovereign wealth fund, while an option, has other economists wondering if it  will work in this country “given our governance problems, it may not be a good idea for congress to create a Philippine sovereign wealth fund.” Countries with sovereign wealth funds like Singapore or Malaysia can take bigger risks than their countries’ central banks.
So how can we control the rapid strengthening of the peso and thus save local industries and the purchasing power of OFW families?
One suggestion is for paying down external debt by buying the dollars from the BSP. The National Government can borrow more domestically than what is needed to finance its deficit and use the excess domestic borrowing to buy dollars from the BSP to retire maturing external public debt.
“The government can expand its capex program (and finance it with domestic borrowing). Assuming it does good projects and improves tax collections, paying the additional debt in the future will not be a problem. In the long run, the projects will raise GDP and tax collections. In the short run, the projects will increase demand for imported inputs (thereby reducing international reserve build up or peso appreciation),” a noted economist observed. 
One economist from the AIM Policy Center, Ronald U. Mendoza thinks something ought to be done to invest our GIR more productively. “To promote more inclusive growth, the returns from public policies and investments need to be robust and inclusive in their benefits to Philippine society. Every single peso and dollar counts. The question is whether the Philippines is investing its $81 billion wisely.”
For now, Tetangco’s caution in handling the exchange rate and how the GIR is invested may prove to be just what a world class central bank governor would do. I guess in the next few months as the peso strengthens to P39 or even P38 to the dollar, BSP’s current strategy will be more seriously questioned.
It would seem however, this is not solely Tetangco’s problem. P-Noy may need to step in and force DOF to do a better job of working with the BSP to look for a solution that addresses all the major concerns for the national good.
Tech support
From Ruth Marbibi.
Tech support: ‘Okay Bob, let’s press the control and escape keys at the same time. That brings up a task list in the middle of the screen.  Now type the letter ‘P’ to bring up the Program Manager.’
Customer: I don’t have a P.
Tech support: On your keyboard, Bob.
Customer: What do you mean?
Tech support: ‘P’.....on your keyboard, Bob.
Customer: I’M NOT GOING TO DO THAT!!!!

Boo Chanco’s e-mail address is bchanco@gmail.com. Follow him on Twitter @boochanco

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