Policy Responses

The role of policymakers is to implement measures that will mitigate the adverse impact of foreign exchange inflows. This section provides an inventory of such measures with emphasis on the role of the BSP.

1987–1997

The surge in the capital account that lasted between 1993 and 1997 led to a persistent appreciation of the peso, in nominal terms between October 1993 and November 1994, and in real terms between April 1995 and June 1997 (see Figure 1 [ PDF 223.2KB | 3 page ] and Figure 6 [ PDF 107.8KB | 1 page ]). Inflation, interest rates and money supply growth were generally higher prior to the crisis (Table 5 [ PDF 46KB | 1 page ]). In response, the government implemented measures that can be classified into four categories: reducing the supply of foreign exchange inflows; increasing the demand for foreign exchange; strengthening prudential regulations; and reducing the cost of production for exporters.

To reduce the supply of foreign exchange in the country, the government cut back on its requests for loan rescheduling under the Paris debt program. Between 1994 and 1997, the government pre-paid a total of $1.41 billion of external debt. Meanwhile, the BSP lifted the restriction on the repatriation of foreign investments made under the debt-toequity conversion program, as well as on the remittance of dividends, profits and earnings that are derived from such investments. It also increased the allowable outward investments that can be sourced from the banking system from $1 million to $6 million per investor per year.

To increase the demand for foreign exchange, the BSP intervened in the foreign exchange market by buying dollars. In some cases the BSP engaged in sterilized intervention by buying dollars in the market while concurrently engaged in mopping up operations by selling government securities in its portfolio to prevent the money supply from increasing. For its part, the national government advanced the phasedown of the forward exchange cover extended to oil firms to add to demand for foreign exchange.

The BSP instituted several measures to reduce the costs of production to exporters to maintain their competitiveness. Direct and indirect exporters were allowed access to foreign currency loans offered by foreign currency deposit units (FCDUs). This led to large savings in interest payments on the part of exporters since interest rate differentials between FCDU loans and peso denominated loans from commercial banks at that time ranged from 5.5–7 percentage points.

Monetary Board Resolution No. 1197 dated December 1, 1994 established an Exporters Dollar Facility (EDF), and the BSP subsequently issued Circular No. 57 dated December 19, 1994. Under Circular No. 57, qualified banks could avail themselves of the EDF against the eligible dollar-denominated loans of their exporter-borrowers (both direct and indirect), including service exporters who were engaged in rendering technical, professional, and other services. On April 27, 1999, the BSP issued Circular No. 199 whereby the EDF was renamed Exporters Dollar and Yen Rediscount Facility (EDYRF). Qualified banks could avail themselves of the EDYRF against the eligible dollardenominated or yen-denominated loans of their exporter-borrowers.

The BSP also added more loanable funds to the system by gradually reducing the reserve requirement on all deposit liabilities from 24% in January 1993 to 17% in August 1994. This contributed to the decline in domestic interest rates.

To prevent banks from unduly speculating in the foreign exchange markets, the BSP reduced the oversold position of banks from 15% of its unimpaired capital to 5%. To weed out the speculative component of portfolio investment, the BSP imposed a prior approval requirement on all forward transactions with nonresidents.

1998–2007

After the crisis, the BSP embarked on an “aggressive and wide-ranging reform process” of the domestic financial system (Tetangco, 2005). One of the objectives was to increase the resilience of the domestic financial to volatility of capital flows and enable it to allocate capital flows more efficiently. The BSP “adopted changes in the regulatory and supervisory framework to be able to effectively meet the demands and challenges of globally integrated financial markets and the growing sophistication of financial products and services. This process of reform is geared towards greater commitment to risk management, strengthening of the regulatory framework and supervision techniques, promotion of transparency and good corporate governance, and putting in place the necessary infrastructure requirements. The BSP, working closely with the banking sector, has made important progress on these fronts.”⁶

Measures to improve monitoring and transparency of capital flows were also introduced. The Philippines started subscribing to the IMF’s Special Data Dissemination Standards (SDDS) in 1996. By January 2001, the Philippines was in full compliance with the SDDS in the dissemination of the relevant data through the internet in accordance with prescribed timeliness and frequency.

To facilitate the adoption of international norms, the Philippines has also been participating in the formulation of Reports on the Observance of Standards and Codes (ROSCs). These reports assess the extent to which the Philippines conforms to various key international standards and codes that are relevant to the effective functioning of its economic and financial system. Resulting gains in transparency are expected to enable market participants to formulate better analysis, forecasts and investment decisions, thus reducing uncertainty and helping investors price risk on a sounder basis. To complement the activities under ROSCs, the Philippines has also been participating in the IMF-World Bank Financial Sector Assessment Program (FSAP), which is aimed at providing a comprehensive assessment of the strengths, risks and vulnerabilities of the financial system.

Apart from its effort at reforming the domestic financial system, the BSP also followed measures similar to those in 1987–1997, particularly reducing the supply of foreign exchange inflows and increasing the demand for foreign exchange. The BSP's main approach has been to liberalize private sector capital outflows in order to reduce the inflows and reserve accumulation. This involved the following:⁷

1. Encouraging investments by overseas Filipinos, initially by facilitating remittances.
   • Promoting transparency and competition in remittances through Circular no. 534 (remittance charges disclosure).
   • Improving payment and settlement systems by approving setting up of local bank’s remittance centers and branches abroad, authorizing rural banks to accept FCDs, approving interconnection of three (3) ATM networks, and approving use of new technologies as mode of remittance (e.g. internet and SMS).
   • Promoting financial literacy campaigns among OFs/families.
2. Encouraging private sector capital outflows through further liberalization of foreign exchange transactions:
   • Phase 1: BSP Circular 561 which involves a symmetrical limit of 20% of unimpaired capital (Oversold/Overbought positions) and increased limit of outward investment by Philippine residents to $12 million/year; and BSP Circular 565 allowing thrift banks to invest in FCD debt instruments.
   • Phase 2: Policy reforms contemplated under this area cover the expanded use of foreign exchange swaps; transactions in which FCDUs of thrift banks/rural banks/cooperatives may engage; increase in the allowed foreign exchange purchases by residents from banks for non-trade current account purposes and outward investments; and streamlining of documentation and reporting requirements to further facilitate the purchase of foreign exchange from the banking system for legitimate trade and non-trade transactions.
3. On other capital account transactions, the allowable outward investments by residents without prior BSP approval and registration was increased from US$6 million per investor per year to US$12 million. For purposes of purchasing foreign exchange from banks, outward investments will now include residents’ investments in foreign currency-denominated bonds issued by the National Government and other Philippine entities. The increase in the allowable limit on outward investments is expected to allow greater portfolio and risk diversification and facilitate integration with global markets.
4. On current account transactions, the limit on allowable foreign exchange purchases by residents from banks to cover payments to foreign beneficiaries for non-trade purposes (excluding those related to foreign loans/foreign currency loans and foreign investments) without supporting documents was increased from US$5,000 to US$10,000. Furthermore, the “no-splitting” restriction and notarization requirement for applications to purchase foreign exchange were also lifted. These measures are expected to facilitate the rising demand by residents for foreign exchange to service non-trade transactions (such as education of dependents abroad, medical care and payment of service fees) which have risen as a result of globalization. Lower transaction costs for bank clients, including retail customers, are expected as a result. While the documentary requirements are being relaxed, these transactions will continue to be covered by existing provisions under the Anti-Money Laundering regulations.
5. There have also been initiatives aimed at improving the BSP’s ability to offset the effects of inflows through proposals to amend the BSP Charter, the most important of which is the proposal to allow the BSP to issue its own instruments like other central banks. The BSP has also made representations with the National Government on its subscription to the P40 billion remaining capitalization of the BSP.

A Closer Look at BSP Intervention

During the period 1998–2007, the BSP continued to intervene in the foreign exchange market. The latter involves the purchase of foreign currency with domestic currency, which changes the monetary liabilities of the monetary authority, and thus the monetary stance. Typically, intervention aims at the following (IMF, 2007b): a) Influencing the level of the exchange rate; b) Dampening exchange rate changes; c) Smoothing exchange rate flexibility; and d) Accumulating reserves.

While not as heavy as in other countries (Figure 2 [ PDF 49.4KB | 1 page ]), based on a calculated exchange market pressure (EMP) index, the intervention was heavier after the crisis (Figure 7 [ PDF 370.1KB | 1 page ] and Figure 8 [ PDF 413.1KB | 1 page ]).⁸ The bars in the figure divide the exchange market pressure on the positive axis into the need to allow the currency to appreciate and a rise in reserves to prevent the appreciation. A useful comparison is the behavior of EMP during the surge of capital flows in 1996 and the surge in 2005.

In 1996, the maximum value of EMP was only 1.3 (August), while in 2005 the maximum value was 4.7 (February), even reaching 9.1 in January 2006. The chart clearly shows that positive changes in international reserves contributed substantially to exchange market pressure.

Not only has the BSP intervened more heavily after the crisis, sterilization has apparently been more pronounced (Table 10 [ PDF 81.8KB | 1 page ]). The sterilization coefficient for the period 1998–2007 is much higher compared to the coefficient between 1987 and 1997.⁹ The coefficient has also been steadily increasing, which can be observed by comparing the regressions for the period 2002.1–2004.12, which is the period when inflation targeting was initiated, 2005.1–2007.8, which covers a period of heavy capital inflows, and 1998.1–2007.8.

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