Sabal: Understanding the exchange rate

Ceteris Paribus

THE value of the Philippine peso to US dollar reached at P54.1 this month. In recent memory, the highest value of the Philippine peso to US dollar was recorded on October 2004 at 56.34, while the lowest was in May 1999 at 37.84.

So what affects the peso-to-dollar exchange? And what are its consequences to our economy?

First, let us understand that there are two policy regimes concerning the setting of exchange rate: the fixed and flexible exchange rate systems.

Under a fixed regime, a country’s exchange rate does not fluctuate against a base currency over a period of time. Key reason to this is because government intervenes to determine the exchange rate value. The other policy regime is sometimes called the “floating” exchange rate system, where the determination of the value is market-driven. Meaning, the exchange rate value is influenced by the demand and supply of foreign exchange not by some level of government intervention.

For instance, the Philippine peso to a US dollar increased from 45 to 50. Under a fixed exchange rate, it is called “devaluation” (its opposite is revaluation). Devaluation means a decrease in the country’s official exchange rate as expressed in the currency of another nation –that in the example above is from 45 to 50 pesos. However, under a floating regime, the increase is called “depreciation” (its opposite is appreciation) or a fall in the price of a nation’s currency.

In the September data, there is a peso depreciation. The Philippine exchange rate system is highly market-driven. Thus, this means that to purchase a US dollar, we need to have at least 54 pesos. This clearly hurts the import sector but benefits the export-oriented industries.

Products that we purchase in the United States will become a bit expensive when sold in the Philippines. Historically, we are a highly importing country. Our country has been experiencing a trade deficit, where imports is greater than exports, for the past 30 years.

To take advantage of the peso depreciation is for the Philippine government to promote exportation. Exports industry clearly benefit from this by receiving a higher peso value from selling a good worth a dollar. However, there’s a caveat, our exports industry will gain big if they are competitive enough in the world market.

Standard development theory explains that a key driver to industrialization is when a country promotes exports, where its earnings will be used to purchase technology from abroad to develop its domestic industries. Singapore and South Korea are good examples, their governments have spent massively to develop their exports sector to make it globally competitive and spur industrialization.

Another consequence to the peso depreciation is a more expensive debt servicing. The Philippine government will now have to pay more peso to supranational organizations (i.e. World Bank, International Monetary Fund) and foreign countries where it has debts to pay. If this depreciation will continue, then this might force the government to cut important government social programs to pay its debts, or worst, increase the tax.

The obvious silver lining to peso depreciation is the favor it gives to our overseas Filipino workers. A higher peso-to-dollar means that the families of our OFW’s will have more money to spend for their respective households. This may lead to higher demand of goods in the economy as a result of the increased of their purchasing power.


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