Simple solution to weak peso problem

The concerns about the peso-dollar exchange rate valuing the peso about 6 percent lower than a year ago are valid. Against the Australian dollar, the peso is almost unchanged. The peso is currently worth 12 percent less against the British pound and the Japanese yen.

This has affected the cost of all goods and services, and combined with the 55-percent increase in the global price of crude oil, the inflation rate is significantly higher.

We are told that we do not need to be rocket scientists to realize our currency exchange rate problem. Considering that “rockets” have been used for fun and fighting since the 13th century, maybe “rocket science” is not the highest intellectual achievement.

The Philippines, like most nations that allow total convertibility of the currency, maintains stability through Central Bank policies. This “convertibility” is important. For example, the Vietnamese dong is not convertible, meaning you cannot exchange dong for local currency in many countries. The State Bank of Vietnam keeps strict control of the exchange rate of the dong into currencies that it wants to hold.

In the Philippines the Bangko Sentral ng Pilipinas (BSP) does not control the peso exchange rate but works only to maintain stability, limiting large swings. Further, its mandate is geared to “influencing the underlying demand and supply conditions.” The free market of buying and selling pesos essentially determines the exchange rate.

The BSP has other policy options, such as moving interest rates, to attract people to buy pesos and deposit money in local banks to earn higher interest than in their home country. As its currency was falling, Argentina raised interest rate to 40 percent in May to attract people to buy the Argentine peso. This action failed as the currency depreciated another 15 percent.

However, there is a solution. The primary policy body of the BSP is its Monetary Board, responsible for making interest rate decisions to “promote and preserve monetary stability and the convertibility of the national currency.” Also, the BSP  “determines the exchange-rate policy of the Philippines.” The BSP “adheres to a market-oriented foreign-exchange rate policy such that the role of Bangko Sentral is principally to ensure orderly conditions in the market.”

But if you let the market determine the exchange rate, then you will have times of depreciation. There is an alternative that Singapore used at the beginning of its economic boom, and which Hong Kong still uses. That is to replace the currency exchange functions of a central bank with a currency board.

The currency board keeps a set exchange rate against a benchmark currency such as the US dollar. Based on that rate, local currency can only be issued in an amount equal to the reserves held in that foreign currency. Complete convertibility is maintained but set at a fixed rate backed by the foreign currency.

The foreign-exchange rate can be changed but this causes fluctuations in the amount of foreign reserves. You need at least 100 percent of the total value of the local currency in circulation to make this work. The Philippines has about 300 percent of the value of liquid pesos held in foreign-currency reserves. We could peg the peso to another currency and set the exchange rate at the best level.

It does not take a rocket scientist to see the choices. If you let the market determine the exchange rate, you have to live with a “weak” currency sometimes. The alternative is to set the exchange rate and have the foreign reserves go up and down.

 

Turning Points 2018
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