Why the peso keeps rising

Why the peso keeps rising
By Cielito Habito
Inquirer
Last updated 08:13pm (Mla time) 10/07/2007

MANILA, Philippines- -LAST WEEK, Bangko Sentral Ng Pilipinas (BSP)
Deputy Governor Diwa Guinigundo was quoted as saying that the uptrend
in the value of the peso vis-a-vis the dollar will continue for the
rest of the year. This is in spite of jitters from rising oil prices
and the credit crunch in the US, and notwithstanding the BSP's
occasional intervention at the spot foreign exchange market to avoid
drastic movements.
I agree with the BSP. Let me explain below why.
Confidence interval
We hear of forecasts that see the peso-dollar rate falling to 43 by
yearend. Even bolder forecasts have it going down to the 40 level.
When asked for my own fearless forecast for the exchange rate, I
always point out that even economists like me are not well equipped to
make accurate predictions about the level that the exchange rate will
settle at within a particular time frame. Not even the most
sophisticated mathematical models of the economy can capture all the
key elements that go into the determination of the actual level of the
exchange rate. I can make a reasonable prediction on the general
direction the rate will take, but don't ask me what the rate will be.
Even if an economist or financial analyst were to give a number, the
"confidence interval" of the estimate (i.e. the range of values the
number could take with no statistically significant difference) would
be so wide as to render the forecast of little use. For example, a
confidence interval of plus or minus 5 percent on a P43:$1 exchange
rate would mean that it could be anywhere between P41 to P45. And
given recent developments, the confidence interval probably couldn't
be narrower than that.
Continuing uptrend
Like the BSP, I believe the peso will continue to appreciate. By the
way, I studiously avoid referring to the situation as having a
"strong" or "strengthening" peso, because that word tends to convey
the misleading notion that the peso's appreciation is a good thing.
Most of us realize that the declining peso-dollar exchange rate is
both good news and bad, depending on who's affected. I have already
written before why under current circumstances, more Filipinos are
probably hurt rather than helped by the peso's continuing rise
relative to the dollar.
So why will the peso continue to rise? It's actually a classic
illustration of the most fundamental principle in economics, the law
of supply and demand. The law simply says that the price of something
goes down when its supply increases, or demand for it decreases, or
both--and vice versa. The dollar is getting cheaper (i.e., its peso
price is falling) because supply of dollars in the country has been
rising, while demand for it has also been falling.
Where does the supply come from? Foreign exchange comes in via export
earnings, spending by foreign tourists, foreign investments, inward
remittances from overseas Filipinos, and foreign borrowings. OFW
remittances and foreign investment inflows are bringing in the surge
in dollar supplies the most. As of July, $8.1 billion of remittances
have already come in this year, a jump of 16 percent over last year's
comparable figure. Net portfolio investment inflows (i.e., "hot"
money) came up to $3.3 billion from January to August, more than three
times the same amount last year. Net foreign direct investment inflows
in the first six months rose 16 percent from last year, to $1.2
billion.
Export earnings (including exports of services such as call centers)
continue to grow as well, albeit at a slower rate than before--and the
slowdown is probably manifesting the expected effect of the
appreciating peso. Foreign tourism also continues to grow, with Korea
being the top source of our foreign tourists. Meanwhile, continuing
foreign borrowings by both government and the private sector also add
to the dollar supplies. And with the multibillion- dollar loans being
offered to us by China alone, domestic dollar supplies would continue
to be pumped up. Interestingly, Thailand has begun to deliberately
turn away foreign funding for its major projects precisely to stem the
tide of foreign exchange inflows.
Slower demand
But the rising peso is also the result of falling demand for the
dollar. Demand comes mainly from importers, and Filipinos who wish to
travel or invest abroad. Our imports actually fell in real terms in
the first half of the year, dropping 11 percent in the second quarter--
which is bad news considering that the bulk of our imports are
production inputs, signaling a slower economy ahead. Demand for
dollars by outbound Filipino tourists and investors is of far less
significance at this time.
The supply and demand story thus easily explains why the dollar keeps
getting cheaper. And the trends aren't about to change in the near
future. The dollar outlook in the world markets is for continued
weakening, especially with the US economy's current woes and the
further easing of US money supply by the Fed. Thus, expect domestic
dollar supplies to continue rising. Demand will rise somewhat if oil
prices spike up, but it seems that the surging dollar supplies will
continue to dominate the picture.
The dollar is at around P45 now. Expect it to get lower for some time
to come.

.

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