GRP Committed to Market-Determined Foreign Exchange Rate

UNCLAS SECTION 01 OF 03 MANILA 002677 SIPDIS SIPDIS SENSITIVE STATE FOR EAP/MTS, EAP/EP, EEB/IFD/OMA STATE PASS EXIM, OPIC, AND USTR STATE PASS USAID FOR AA/ANE, AA/EGAT, DAA/ANE TREASURY FOR OASIA USDOC FOR 4430/ITA/MAC/ASIA & PAC/KOREA & SE ASIA/ASEAN E.O. 12958: N/A TAGS: EFIN ECON PGOV RP SUBJECT: GRP Committed to Market-Determined Foreign Exchange Rate Policy Refs: A) 06 Manila 5050 B) Manila 1859 SENSITIVE BUT UNCLASSIFIED -------------- Summary -------------- ¶1. (U) In a variety of public fora, Philippine Central Bank Governor Amando Tetangco has said the GRP remains committed to a flexible, market-driven foreign exchange rate policy. Although the GRP has undertaken measures to assist affected sectors, he rejected capital controls and calls from exporters for more aggressive intervention in the foreign exchange trading market to arrest the peso's rise. GRP officials believe that the peso's appreciation since 2005 has generated net benefits for the economy by helping temper inflationary pressures; allowing the Central Bank to build up international reserves; providing public and private sectors an opportunity to retire foreign debt obligations; and reducing peso requirements for foreign debt service payments. Officials appear more concerned about potential vulnerabilities and disruptions from swift reversals in investor sentiment that generally characterize portfolio capital investments. End Summary. -------------- Peso Surges, Exporters Complain -------------- ¶2. (U) The peso, currently trading at a seven-year high of around PHP 45.5 per USD, has appreciated more than 7% year-to-date and has surged ahead of other Southeast Asian currencies since the beginning of the year. Complaining of waning competitiveness and mounting losses, export groups have called on the central bank to intervene more aggressively to stabilize the exchange rate at around 50 to the USD. They warned that the strong peso adversely affects recipients of remittances from Overseas Filipino Workers (OFW),dampens tourism, and subjects domestic producers of import substitutes to stiff competition from cheap imports. -------------- Market-Driven Exchange Rate Policy Stays -------------- ¶3. (U) Central Bank Governor Amando Tetangco has reiterated in various fora that the Philippine Government remains committed to a market-driven foreign exchange rate policy. In a recent briefing with the American Chamber of Commerce of the Philippines, he stressed that the Central Bank does not target a specific exchange rate. The agency focuses its intervention in the inter-bank trading market to smooth excessive volatility and temper speculative pressures. The Governor also ruled out controls on portfolio capital flows, which have contributed significantly over the past several months to the peso's strength. As of mid-July, net inflows of foreign portfolio capital had more than tripled to nearly USD 3 billion over the preceding 12 months, with most of these funds going into the local stock market. -------------- Pesos Still Within Equilibrium Range? -------------- ¶4. (U) Governor Tetangco commented that the peso's appreciation since 2005 has not necessarily translated into a significant reduction in export price competitiveness. Compared with a trade-weighted, inflation-adjusted basket of competitor currencies, he estimated that the peso's appreciation since 2005 has merely offset the local currency's significant 2002-2004 decline, triggered by domestic fiscal worries and political uncertainties. ¶5. (SBU) The Governor warned of inherent difficulties in determining "equilibrium" exchange rate levels, but estimated the current range at somewhere between 42 and 49 to the USD. Although the peso has been rising since 2005, Tetangco observed that the rate of growth of exports has accelerated over this period (15% in 2006 and 8% thus far in 2007). Other Central Bank officials commented in separate occasions that a stronger peso translates to cheaper peso expenditures for inputs of the import-dependent electronics sector, partially offsetting lower peso proceeds from export sales. Tourist arrivals and receipts continue to grow, and imports have not surged as feared. OFW remittances expanded by nearly 20% during 2006 to USD 12.8 billion and were up more than 20% year-on-year as of MANILA 00002677 002 OF 003 mid-2007. ¶6. (U) The Central Bank Governor cited studies indicating that export competitiveness does not hinge on exchange rate policy alone. Achieving and sustaining long-term export competitiveness depends just as heavily on sound and stable macroeconomic, investment, and trade regimes. Critical factors for a resilient and vibrant export sector include a productive and skilled labor force, access to affordable credit, efficient infrastructure, technological investments, and aggressive marketing efforts. -------------- Benefits of Strong Peso -------------- ¶7. (U) Assessing the currency appreciation's overall economic impact thus far, Governor Tetangco said the peso's strength has brought benefits to the economy that offset the disadvantages to certain sectors. The stronger currency dampened inflationary pressures from increases in international prices of imported commodities, including oil and petroleum products. The Governor estimated that the cumulative appreciation of the exchange rate over the past 2 1/2 years from 56 pesos/USD to 45 pesos lowered inflation by 2.5 percentage points, benefiting both consumers (including OFW beneficiaries) and producers. ¶8. (U) The stronger peso has allowed the Central Bank to build its international reserve buffer to a more comfortable level. Gross international reserves hit a record $26.4 billion in June, equivalent to 4.8 months import cover and to 2.5 times the foreign debt maturing over the next twelve months. While Central Bank foreign exchange purchases help to temper the peso's rise, the Bank generally attempts to sterilize reserve inflows to prevent excess liquidity from threatening inflation targets. ¶9. (U) The local currency's appreciation has also provided both the public and private sectors the opportunity to pre-pay foreign debt obligations -- $4.4 billion during 2006 and $1.4 billion so far in 2007 -- helping to reduce the Philippines' foreign debt ratio from 55% to 45% of Gross Domestic Product (GDP) between the end of 2005 and 2006, respectively. Pre-paid debt included the Government's remaining $220 million obligation with the International Monetary Fund (IMF),ending 4 1/2 decades of IMF supervision. ¶10. (U) Two years of peso appreciation has dropped the Philippines' foreign debt-to-GDP ratio below the IMF's 60% vulnerability threshold, a development welcomed by credit rating agencies and rewarded by foreign capital markets through narrower risk premiums for Philippine debt. Tetangco believes that the strong local currency will encourage more debt retirement and noted room for further improvement vis--vis debt ratios of similarly-rated, emerging-market economies. -------------- -------------- Currency Appreciation "Net Positive" for GRP Finances -------------- -------------- ¶11. (U) Department of Finance (DOF) officials described the overall impact of a strong local currency as "net positive" for National Government finances. Lower peso requirements for servicing foreign loan obligations more than offset reduced peso receipts from Customs collections. The DOF estimated the net benefit from a stronger than expected exchange rate at about 2 billion pesos in 2005 and 12 billion pesos in 2006. -------------- - But GRP Not Unsympathetic to Exporters Plight -------------- - ¶12. (U) Although it remains committed to a market-driven exchange rate, the Philippine Government recognizes the adverse impact of the currency's appreciation on small exporters that depend mainly on domestic inputs. The GRP has taken a number of other measures to assist exporters. Citing increasing demand for foreign exchange because of globalization, the Central Bank relaxed foreign exchange regulations in March 2007 by doubling allowable over-the-counter foreign exchange purchases from banks for non-trade and non-debt purchases to USD 10,000, and for outward investments by residents to USD 12,000. ¶13. (U) To enhance exporters' access to credit, the Central Bank established a USD 500 million Exporters Dollar and Yen Rediscount Facility. The government-owned Development Bank of the Philippines MANILA 00002677 003 OF 003 recently opened a USD 1 billion foreign exchange hedging facility for exporters. -------------- Comment -------------- ¶14. (SBU) The Philippine Government generally considers the peso's appreciation as a "pleasant challenge" and a reflection of very liquid global financial markets seeking to invest in emerging economies with improving macroeconomic situations (Ref A). Pro-Administration politicians have bandied the strong peso as a vote of confidence for the Arroyo administration. Central Bank officials privately fear that a false sense of complacency may begin to set in and stressed the urgency of undertaking and sustaining reforms to boost foreign direct investment levels, promote long-term export growth, and harness non-debt sources of foreign exchange by addressing slipping competitiveness rankings (septel). They emphasized the need to address persistent revenue collection problems (Ref B) that could seriously undermine the current cautious optimism here. Jones