THE last weeks have seen weakening in the financial markets. The stock-market index has lost roughly 300 points from July 1, or 3.6 percent. This was after it has reached a peak of 8,100 in end-July. The peso-dollar rate, meanwhile, hit a nine-year high of 48.26. At this level, the peso has depreciated by about 2.4 percent from the start of the year. These “weakenings” have been attributed to the political noises that have been hugging the headlines. No doubt they have stoked worries among local and foreign investors. It is important, therefore, to look into the details of what has been happening in a broader and a longer context. Ultimately, we need to look at the strength of the foundations regardless if the storm is political, local or international.
It would be helpful to look at one of the key balances of the economy, which is the balance of payments (BOP). This balance, more or less, provides us the fundamental direction of the foreign exchange. The BOP consists of a capital account and a current account. The capital account includes direct and portfolio (stocks and bonds) investments or financing, while current account includes our trade transactions (exports and imports), overseas Filipino workers (OFW) remittances, tourism and business-process outsourcing (BPO) services. The current account represents our regular transactions with the world. In here, imports have historically been larger than exports, leading to a current-account deficit. The deficit requires that we need more foreign exchange to bridge this gap. In the past, our lack of foreign-exchange sources, other than exports, has pressured the currency to depreciate or even devalue. However, beginning the mid-2000s, we have been reflecting current-account surplus. Meaning, even if our imports are larger than our exports, other sources have been funding the differences. These are our OFW remittances and, recently, BPO inflows and tourism. Last year these three sources have approximately provided about $60 billion to the economy. Hence, this means that there is enough foreign exchange to pay for our global transactions. In fact, our current level of gross international reserves (GIR) has now reached $85.6 billion, which is good enough to pay more than 13 months of our import requirements. In the past, when devaluations occurred, our GIR was not even enough to pay three months of our imports. The import value of our GIR is much better than Indonesia (10), Malaysia (7) and Singapore (10). Hence, from a fundamental perspective, the peso-dollar rate is not pressured by lack.
But why is the peso weakening against the dollar? The foreign exchange is just like any other product that has a value. The value is determined by the demand and supply for it. It is determined daily. The daily users of foreign exchange are mostly firms engaged in exports and imports, families of OFWs and investors (particularly portfolio—which can go in and out of our markets at any time).
Any of these three groups could strongly drive the daily direction of the exchange rate. In the last three years, the peso has been depreciating against the dollar (0.51 percent in 2013, 4.4 percent in 2014 and 2.4 percent in 2015) despite the inflows. This is mainly due to external factors, primarily the possible US interest-rate hike, which has been inviting back investments. In this recent episode of depreciation, it is interesting to look at the volume of trade. The volume of trade from September 23 up to 27 were high, but went down on September 28, when it appreciated. It is possible that the weakening of the peso was driven by import payments for stocks for the Christmas season or capital importation. This seems to be the pattern in the last four months of the year as reflected in 2014 and 2015. In fact, it was expected that the peso would appreciate in November and December due to remittances, which are seen strongest during these months, but the inverse happened. Hopefully, the weakening of the peso, if mainly due to imports, will contribute to better economic growth in the coming years. We note that in the period January to June 2016, imports of capital goods have increased 60 perecent, based on PSA data.
In regard to the stock market, we have maintained our view at the start of this year that the PSEi is expensive. Our year-end estimate is 7,500, or a full-year return of about 7 percent. This is just about the same as GDP growth. The average price-earnings (PE) ratio of the PSEi is 16.5x. At 8,100 it has reached 22x. This is the most expensive in Asean and this is also making investors take a second look at our valuations. What about the political noises? The chart below shows the market valuation through the years. It would seem that politics play a smaller role in relation to values rather than
external factors.
At the moment, the factors above may be the ones driving the markets. It may be early to judge said noises as the main factors for weakness. Nonetheless, it is important to note that confidence is more important than valuations in a global environment. Thus, when expected fundamental valuations are breached, that is another story.