Bunye: How the exchange rate affects us (1st of 2 parts)

Sunday, November 14, 2010

THERE is an ongoing debate as to whether the present appreciation of the peso is good or bad news for our country.

Last week, the peso was valued at P42 to one US dollar, which alarmed some sectors in the Philippine economy, particularly the families of migrant Filipino workers and the export industry.

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It can be recalled that in 2007, the Philippine peso emerged as one of the top performing currencies in Asia and hit a 7 and ½-year high of P41 to US$1 in December of that year.

According to the Department of Economic Research of the Bangko Sentral ng Pilipinas, a firm currency is generally welcome news as it reflects positive developments in the country’s economic fundamentals.

Filipino consumers benefit greatly from a firmer peso because it means lower prices in peso terms for imported goods and services.

For example, a strong peso can shield our country from high world oil prices. Thus we are protected from consequences such as higher jeepney fares and transportation costs, and ultimately, steeper food prices for Filipino consumers.

But for sectors such as exporters and OFW dependents, whose earnings are denominated in US dollars, a firmer peso is a negative development. Peso appreciation means that they would now receive less pesos for every dollar they exchange.

So what really is this peso-dollar exchange rate, and why is it important?

The exchange rate is the price of a unit of foreign currency in terms of the domestic currency. For example, the exchange rate in the Philippines is conventionally expressed as the value of one US dollar in peso equivalent (i.e. US$1 = P42.00).

The BSP Department of Economic Research explained in a primer that the exchange rate is important for the following reasons:

First of all, it serves as the basic link between the local and overseas market for various goods, services, and financial assets.
Using the exchange rate, we could compare the prices of goods, services, and assets quoted in different currencies.

Exchange rate movements can also affect actual inflation as well as expectations about future price movements. Changes in the exchange rate tend to directly affect domestic prices of important goods and services.

A stronger peso, for instance, lowers the peso prices of imported goods and import-intensive services such as transport, thus lowering the rate of inflation. For instance, an increase in the value of the peso from $1:50 to $1:P40 will lower the price of $1 per liter gasoline from P50.00 (P50 X $1) to P40 (P40 X $1).

Exchange rate movements can also affect the country’s external sector through its impact on foreign trade. An appreciation of the peso, for example, could lower the price competitiveness of our exports compared to the products of competitor countries whose currencies have not changed in value. Remember, however, that there are other factors, besides exchange rate that determine external competitiveness, e.g., quality of goods, packaging, market diversification.

Lastly, the exchange rate affects the cost of servicing (including the principal and interest payments) on the country’s foreign debt. Peso appreciation reduces the amount in pesos needed to buy foreign exchange that would pay for interest and maturing obligations.

(Concluded next week)

Note: You may email us at totingbunye2000@gmail.com. Past articles may be viewed at http://speakingout.ph/.