The Philippine peso closed at 46.60 last Friday, its highest level in six years. Since the start of the year, it has also outperformed most of its Asian counterparts, appreciating by 4.9 percent against the dollar with only the Indian rupee trading higher in the region. The peso is now poised to reach our yearend target of 46 sooner than expected.
While there may be interventions from time to time by the Bangko Sentral ng Pilipinas (BSP) to mitigate sharp moves in the foreign exchange, we remain bullish on the peso for the following reasons:
1. General weakness of the dollar. Despite attempts of most Asian Central Banks to keep their currencies from further strengthening against the dollar, the pace of appreciation seemed to have increased over the past two months. The Indian rupee, which was quite stable from January to March for example, suddenly moved eight percent higher in just two months. This is an exceptional move given that the Reserve Bank of India has been managing its exchange rate closely with the rupee appreciating by only 1.8 percent in 2006 and 3.6 percent in 2005. Likewise, the Malaysian ringgit began accelerating against the dollar in mid-March following announcements of key economic reforms. The Philippine peso, meanwhile, has been on a gradual appreciation since the start of the year primarily due to healthy remittances and capital inflows, and a generally peaceful election period. Finally, the baht is still up 2.3 percent against the dollar despite earlier attempts of capital controls by the Thai government.
Meanwhile, resource-based currencies like the Canadian dollar and the Aussie dollar have appreciated strongly against the US dollar, up 6.6 percent and 4.4 percent, respectively. The euro, which went as high as 1.3678, and the British pound, which reached 2.01 against the dollar has since corrected.
2. Strengthening macro fundamentals. The Philippines is currently enjoying its longest streak of economic growth, posting 32 consecutive quarters of positive economic growth since 1999. And despite slower global economic growth and trade expectations this year, the Asian Development Bank (ADB) forecasts the Philippine economy to expand at the same pace of 5.4 percent. Low real interest rates, higher fiscal spending on priority projects this year and a recovery in investments should support growth.
3. Healthier external balances. OFW remittances are projected to remain at about 11 percent of GDP which should help boost the current account to a healthy surplus this year. Meanwhile, the privatization of several government assets which started late 2006 (raising P4.6 billion through PNOC-EDC public offering) and carried over this year (sale of P25 billion PLDT stake), plus the pick-up in FDI and portfolio inflows should contribute to a surplus in overall balance of payments. In addition, we have yet to see the additional strong dollar earnings from mineral exports which should grow by leaps and bounds.
4. Fiscal consolidation on course. The government’s fiscal program remains largely on track. The fiscal deficit has been reduced from 5.3 percent of GDP in 2002 to only one percent in 2006. This was mainly achieved thru the implementation of the EVAT and weak public expenditure. While public spending especially on key infrastructure projects is expected to kick in this year, the additional asset sales through the government’s privatization program should keep the deficit below one percent of GDP. In addition, the strong peso and low interest rates should result in lower-than-expected debt interest payments.
Boon or bane to certain sectors
A strong peso can be boon or bane for companies depending on their cost structures and revenue sources. There was a time that an appreciating peso has negative consequences for exporters and those whose revenues are in foreign currencies. However, this rule of thumb no longer holds as most companies have opted to prepay their foreign debt. At any rate, we believe a strong peso has the following impact on the sectors identified below.
1. Utilities. Power generators and distributors as well as water utilities should be able to book forex gains on account of their considerable foreign debt load. However, power rates are also linked to the forex rate. A climbing peso will tend to bring down tariffs. Unless this is compensated by higher consumption, revenues of utilities could take a hit from a strengthening peso. In terms of costs, there are power generators whose power plants are run by contractors under BOT agreements. These contractors are partly paid in foreign currencies. Thus, a rising peso should mean savings in terms of the peso translation of dollar-denominated contractor fees.
2. Consumer. These companies are currently burdened by high world commodity prices. Thus, a strong peso should provide some relief in terms of lower peso translation of imported raw materials. For Philippine companies that derive part of their revenues from abroad (i.e., San Miguel, Univeral Robina Corp. and Jollibee Foods), the impact of a strong peso would depend on the proportion of overseas revenues. In the case of Jollibee, revenues derived abroad account for less than 15 percent of total revenues. Thus, the peso appreciation should not be that detrimental to its profitability. To the contrary, this should even be net positive for the company given that up to 15 percent of its costs are on imported materials while most of its equipments are also bought in dollars.
3. Mining. While a strong peso could weigh down on revenues, this is far outweighed by the prevailing high world metal prices.
4. Telecommunications. The negative impact of a strong peso on dollar-linked revenues (i.e., international long distance revenues and CERA-linked monthly basic fees) is balanced out by net forex gains and interest savings on foreign debt. Note that most telecom companies have incurred heavy foreign debt to finance heavy capex for rollout. Thus, foreign exchange appreciation is revenue neutral.
Bottom Line
The Philippine peso remains fundamentally sound and could reach our year-end target of 46 sooner than expected. By then, we would have to re-evaluate and most likely upgrade our target for the peso. However, to preserve price competitiveness of our exports against the backdrop of slowing global trade, the BSP may again accumulate foreign exchange reserves to stem the pace of the peso’s appreciation. The increase in reserves which already amounted to $23 billion as of end-2006 (or more than four months of import cover) may be used further to prepay external debt just as the government did in December 2006 when it paid back early $220 million of loans from the International Monetary Fund.
Thus, while BSP intervention may slow down the rate of the peso’s appreciation in the short-run, the virtuous cycle of debt reduction and steady economic growth, plus strong OFW remittances, FDI and portfolio inflows will maintain upward pressure on the peso in the long-term.
For comments and inquiries, you can email us at info@philequity.net or gime10000@yahoo.com.