The peso exchange rate and the economy

Most Filipinos have gotten used to the idea that P50 would exchange for one US dollar. Though there are daily changes due to market fluctuations, in general, such values have stayed at P50 to the dollar in the course of many years.

Lately, however, it takes P57 to exchange for one dollar. The change in value has become noticeable. The peso has weakened (or depreciated) in relation to the US dollar.

Recent peso depreciation. The recent peso depreciation is the result of many forces interacting. Domestic inflation accelerated (see previous columns on this).

Two major events also took place: (1) The war in Ukraine, which led to the sudden rise of energy and food prices, and (2) The US Fed’s aggressive program of raising policy interest rates to combat domestic inflation has caused a weakening of most currencies against the dollar.

While the first event threatened a reduction of energy and food supplies because Russia’s supply of energy was taken out of usual channels and the threat of energy cut-off became real, this stoked uncertainties about supplies and affected price expectations.

But the actual economic situation of the moment also plays an important role.

To demonstrate this, it is useful to look at the peso depreciation in relation to what is happening, as well in other countries. Each country is different, and economic forces of the moment, plus the past history of each country, are important relevant information that helps to explain current developments.

I constructed a table of foreign exchange index for several countries in our immediate region, along with the Philippines, using the start of the Ukraine war as the base index. I track two other dates to examine the path of currency movements: (1) Late May, the start of the new Marcos government; and (2) Sept. 9, a most recent date.

The table shows the exchange rates of the local currency in terms of the US dollar for China and five major ASEAN countries – Malaysia, the Philippines, Singapore, Thailand, Indonesia and Vietnam.

All exchange rates of each country appear as 100 percent for Feb. 24, the common basis of comparison, but are higher in the two other dates if the currency has weakened. (On Feb. 24, the Philippine peso was 51.27 to one US dollar; in late May, it was 52.35 pesos; and by Sept. 57.14 pesos.)

Each country tells a unique story, but the rate of depreciation of the particular currencies reveals more about the underlying strengths and weaknesses of each economy during the current period under examination. Also, past history matters a lot!

During this limited time span of a half-year in 2022, most ASEAN countries have experienced more moderate currency depreciation and also more moderate inflation. One major reason for this is that they have been economic “winners” in the current set of developments.

Malaysia, Indonesia, Thailand, and to a less extent Vietnam, have less energy dependence on global trade as they produce oil and gas. They have been very successful winners in redirecting capital flows into their economies in the course of past decades and, as a result, have become manufacturing hubs in the Southeast Asian region for exports to other countries. A major outcome is that these countries have become export surplus economies. Thailand’s economy has a strong agricultural export base and is a very successful industrializer. Their economies are also food surplus producers. Indonesia may be importing rice for part of its needs, but its palm oil exports are dominant in world trade.

Two late industrial latecomers in ASEAN – Indonesia and Vietnam – got to their level of economic pre-eminence through very gradual currency depreciations taking place over two decades to the present. This was accompanied by domestic inflation rates.

Between 2000 to 2021, Indonesia experienced currency depreciation amounting to 80 percent. Vietnam underwent depreciation equivalent to almost 70 percent. It is interesting to note that these two economies have experienced the most stable exchange rates in 2022, with the Indonesian rupiah even strengthening at a time when all the other currencies were depreciating.

During the period under study, the Philippines shares with Thailand and China the highest rate of currency depreciation. All three countries have tracked roughly their currency experience. During the mid-2010s, they had relatively strong currencies. In 2022, currency depreciation took place in relation to the stronger US dollar.

US Fed anti-inflation moves. The US Fed began raising policy rates aggressively since May and have followed this through to July, with prospects for more. These moves helped strengthen the US dollar on a global scale.

The Asian economies put in place policy rates of interest that suited their needs and in relation to their perceived economic strengths.

The interest rate policies established by Indonesia (at 3.5 percent) and Vietnam (four  percent), and in place at the start of the year have remained unchanged because they continue to attract foreign capital and their economic performance have been strong in this recent period. Thailand, much more endowed with high trade surpluses and a strong manufacturing economy, adopted a policy rate at a low level of interest – 0.50 percent. In late July, it raised the policy rate below those set by the US Fed so that its interest policy rises to 0.75 percent.

A currency depreciation can produce some useful economic impact. It can reduce imports and induce more earnings of dollars from exports and other revenues.

If, as the table suggests, China, Thailand and the Philippines are experiencing a currency depreciation of 10 percent, a relevant question is which country or countries will likely experience a bigger beneficial impact? The answer is the country or countries that possess a bigger and more flexible industrial base.

This is one more important reason why the Philippines needs to pursue bold economic reforms to open the economy more, especially during difficult times such as ours.

For archives of previous Crossroads essays, go to: Philstar.com. Visit this site for more information, feedback and commentary: http://econ.upd.edu.ph/gpsicat/