FALSE ALARM: AFTER 2-DAY LOSING STREAK PHL SHARES BOUNCE BACK
MANILA, JULY 11, 2011 (MALAYA) BENJAMIN DIOKNO (‘Peso appreciation, arising from unrestricted inflow of hot money, is the worst thing that could happen to a labor-surplus economy like the Philippines.’)
AFTER a two-day losing streak, Philippine share prices bounced back on Friday on the back of a ‘surprisingly strong employment report’ in the U.S, according to a news report. That report turned out to be a dud. The unemployment rate edged up to 9.2 percent in June, its highest in 2011.
The fact: a dismal 18,000 new non-farm payroll jobs were created in June, the fewest number of jobs in nine months. Meanwhile, the number of new jobs created in May was revised downward to 25,000, less than half the original estimate. To put these jobs numbers in perspective, some 9 million jobs were lost in the US during the recent Great Recession, and only 2 million jobs have been restored to date. Some economists estimate that it would take another 4 to 7 years before job situation is restored to its pre-crisis level.
With the US economic recovery apparently losing steam, the market reaction was swift. Stock indexes plunged on Friday, erasing much of the week’s gain.
How will the local stock exchange react to this false report? Hard to say. For some reason, the local stock market has managed to ignore the uncertainty brought about the faltering US economy, the deepening financial crisis in Europe and even the slowing growth in China. Perhaps, these fears are more than offset by the massive inflow of portfolio investment or ‘hot money’ --‘massive’ relative to the market capitalization of listed companies as percent of GDP.
As a result of the expansionary monetary policy in response to the Great Recession, there’s a lot of short-term funds in the global financial system in search of high returns. With most of the developed world (Europe, Japan and the US) experiencing financial crisis, recession, and weak recovery, these portfolio investments are attracted to fast growing Asia. This may explain the relatively high inflow of portfolio investment in the Philippines.
This relatively heavy inflow of hot money into the Philippines is largely responsible for the brisk activity of the local stock market. But policymakers are supposed to know the downside risk of hot money. It magnifies expansion when the economy is expanding, but it intensifies the contraction when investors smell trouble or when other markets become more attractive.
Policymakers are supposed to know the adverse impact of hot money on prices, the economy, and jobs.
On the one hand, heavy entry of hot money may lead to inflationary pressure. High liquidity is not matched by higher output since footloose capital does not necessarily lead to new factories or higher outputs. One way of controlling inflation is to raise interest rates, of course. But that’s the wrong move. Increasing interest rates will only attract more hot money, especially since the US Fed, with the economy facing a weak recovery, may keep its low interest policy unchanged at least while the recovery remains weak.
On the other hand, if nothing is done to slow the inflow of hot money, it may lead to peso appreciation. This, no doubt, will help BSP keep prices stable. But there is a huge cost to BSP too. The peso value of its international reserves falls by the amount of the appreciation of the peso.
The peso appreciation affects consumption, output, and employment. It imposes additional costs to families of foreign-exchange earning Filipino overseas workers, Filipino firms operating abroad, and exporters. It’s like an additional tax on these workers and firms, except that the government never get to collect the tax.
The peso appreciation reduces the peso value of the dollar remittances from abroad. With dollar remittances from OFW expected to slow to say, 5% to 7%, as opposed to its peak of 25%, the growth of the peso value of OFW remittances may be either a constant or a slight negative.
For example, a 5% increase in OFW remittances accompanied by a 5% peso appreciation, will keep OFW remittances unchanged. This means no increase or decrease in the peso value of the remittances, in nominal terms; but correcting for inflation, it means a contraction. And with contraction in real overseas remittances, consumer spending will fall.
With the shrinking peso value of remittances, there may be other reasons why a typical Filipino overseas worker and his family may save more or spend less: the uncertainty due to potential job loss or non-renewal of contract, and further slide in the peso-dollar rate. Multiply this consumer behavior many times over, and the result will be either constant or slightly lower consumer demand.
But that’s not all. With an appreciating peso, it is cheaper to import than to produce goods at home. That’s bad news for import-substituting industries and agriculture; this means, we’re giving up jobs at home and creating jobs abroad.
Peso appreciation also makes Philippine exports more expensive and thereby less attractive for consumers in importing countries. Lower exports means fewer jobs at home.
In sum, peso appreciation, arising from unrestricted inflow of hot money, is the worst thing that could happen to a labor-surplus economy like the Philippines.
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