The Effects of a Devalued Peso

Saturday, July 02, 2005

[This is my reply to the message posted by Ogie Reyes on the Cebu Politics Yahoogroup. He is the moderator of the group and his reply to my article, "What truth?", was:

To immediately put your fears to rest, Larri, you are not going to lose your job on account of Mon's anti-GMA stance; neither will your American employer close shop and leave RP. For the past three EDSAs and several attempted coups, Cebu has always been far from the "maddening" crowd and practically free of destruction. If your company is an export company it will enjoy the new low peso-dollar rate. Timex Phils, where my brod-in-law was once its president, would celebrate each time the peso went down.]

Pardon me for saying this, but this is a narrow, if not crude way, of analyzing the effects of a devalued peso.

Allow me first to discuss three major disadvantages that far outweigh the benefits you just cited, before I prove that your theory that a fluctuating peso will spawn foreign investments is, at best, fallacious.

FIRST: A fluctuating peso encourages speculation on the dollar, which forces the Central Bank to compensate by (1) buying more dollars off the market to keep it stable, or (2) raising interest rates to make it more expensive for speculators to borrow money to fund their speculation.

Option 1 cannot be sustained for a long period because it increases the money supply; and, if you're an economist, you should know this will cause the inflation rate to shoot up.

Option 2 is bad for local business, as this makes it expensive to borrow money to fund operations. Now, you wonder why Alan Greenspan is such a powerful figure in the world today. He controls the interest rate of the U.S., the world's largest economy. If interest rates remain high, "local factories" -- as opposed to those at MEPZ -- will close one by one.

SECOND: A devalued peso makes our foreign debt expensive to service and it consequently erodes the value of our foreign reserves. As of March, our foreign reserve stood at about US$17 billion. A peso or two drop in the forex will translate to a staggering erosion of this reserve.

As our debt become more expensive to service, we move closer to a default. The alarm sounded by the so-called U.P. 11 about a looming Argentina-like financial crisis is even more true today than last year. Allow the peso to breach the US$60 level and this country will disintegrate faster than you can say "yehey!"

Please think of this, sir, before you and your brod-in-law celebrate the next drop of the peso.

Meanwhile, continued uncertainty will trigger a downgrade in our credit rating. Each downgrade translates to PHP20 billion in additional interest payments for us. Just last month, Ecuador and Bolivia suffered a downgrade due to the growing political uncertainty in both countries. Let me direct you to this newsletter for your further enlightenment: http://bankrupt.com/periodicals/sdr.html

THIRD: A devalued peso makes imported inputs of production expensive. One such input is oil. As you know, sir, we source our oil abroad and we pay in dollars, not peso. Higher oil prices mean higher production cost that manufacturers pass on to consumers in the form of price increases. Sooner or later, drivers will demand a fare hike that, if unheeded, will result to transport strikes.

A persistent increase in the level of consumer prices is called inflation. And any economist will tell you inflation is a bad thing. It not only erodes the purchasing power of ordinary workingmen like me, it triggers an increase in interest rates.

Now, this is where I disprove your fallacious theory. You claim that a devalued peso attracts foreign investors because local labor becomes cheap. Theoretically true, but in reality FALSE.

Two reasons:

(1) As the inflation rate rises -- or as transport fares and consumer prices go up -- ordinary workingmen like me will demand a wage hike. Don't be naive, sir, the PHP200 daily wage will not stay that way for long. Workers will demand higher wages the moment prices of basic commodities become too expensive.

Now, you tell me how our labor force will still remain cheap!

(2) Investors don't look at the price of a country's labor force alone. Obviously, you are not a foreign investor and "based on my reading" you are neither a businessman. Because if you are, you have a questionable business acumen.

Foreign investors, especially those looking to relocate manufacturing operations abroad, also look at political stability. Why? Putting up a car-making facility, for instance, requires millions of dollars in capital investments. Businessmen need to be assured that tomorrow or a week from now no coup d'etat will lead to the closure of airports/piers that will delay the delivery of their goods to customers abroad. Foreign investors would rather set up shop in Vietnam where the labor force is not only cheap, the socio-political climate is stable.

Now you wonder why only call centers are sprouting in the Philippines and not manufacturing operations. The answer is simple: putting up a call center is not capital-intensive. You only need computers and Internet/phone connections to be in business.

But call centers only employ a small portion of our labor force -- only those who can speak English fluently. This country needs investment in manufacturing industries to solve its chronically high unemployment rate. We need factories for car-assembly, for instance, to (1) encourage transfer of technology, (2) employ a greater portion of our labor force and (3) fuel the rise of related and downstream industries.

I hope this clears up your head.