Sta. Ana coordinates Action for Economic Reforms. This article was published in the Opinion Section, Yellow Pad Column of BusinessWorld, January 14,2008 edition, pages S1/4 and S1/6.

Mrs. Gloria Arroyo has always trumpeted the appreciating peso as one of her major economic accomplishments.  But in a recent speech on the occasion of the 107th anniversary of the Manila Police district, Mrs. Arroyo sings a slightly different tune. She said, “Now our problem is not how to defend the peso but to somehow temper the peso’s strength.”

Why she said this before the Manila police is puzzling.  The police are not really knowledgeable about economics.  But that Mrs. Arroyo spoke about the appreciating peso in a gathering of supposedly economically illiterate police indicates that almost everyone is now aware of the problems created by an appreciating currency.  Possibly, members of the Manila police also depend on the remittances of wives or mistresses working overseas. Or possibly, some of Manila’s Finest are having a difficult time mulcting local businessmen who are complaining about losses from the currency appreciation.

But wait.  Mrs. Arroyo’s statement is confounding.  Even as she belatedly recognizes the pitfalls of an appreciating peso, she thinks it is still good to have a strong peso.  For she likewise said that the appreciating currency is “a better problem rather than the other way around.”

That’s a confounding statement.  Either it’s a pure and simple spin or it betrays her ignorance of sound economics.

What in effect Mrs. Arroyo is saying is that the appreciation of the peso is okay and that’s better than a depreciating currency.  What has to be tempered is the peso’s rapid appreciation.

In fact, long before this latest pronouncement of Mrs. Arroyo, the Bangko Sentral ng Pilipinas (BSP) has been undertaking measures to slow down the currency appreciation.  It has intervened in the foreign exchange market by purchasing US dollars.  It has prepaid a significant part of its foreign debt.  It has liberalized the outflow of foreign exchange.

The intent of these measures, to repeat, is to slow down the peso appreciation and to smoothen the price fluctuation.  The measures—and they are indeed welcome—are not intended to induce a reversal that leads to the depreciation of the peso. In this regard, expect the peso to continue appreciating but not in rapid fashion.

The institutional bias of the BSP is for low inflation, which makes it reluctant to favor a depreciation. Nevertheless, we contend that pursuing a competitive exchange rate does not necessarily contradict the objective of having low inflation. The current inflation rate is quite low—about three percent—which gives the BSP enough room not only to resist further appreciation but to allow a depreciation.

Time and again, we, together with many economists like Raul Fabella, have advocated a competitive exchange rate. Even the World Bank and the International Monetary Fund favor a more competitive exchange rate.

What a competitive exchange rate is debatable.  At the very least, the Philippine peso should not be overvalued.  We estimate that the overvaluation of the Philippine peso is about to reach 15 percent. Recall that a factor behind the 1997 financial crisis was an overvalued peso.  We have not yet reached that degree of overvaluation in 1997, but the current trend is already a cause for alarm. The Bank of the Philippine Islands (BPI) forecasts that the exchange rate may even settle at PhP37 per US dollar.

But like Fabella, we are not content with simply avoiding overvaluation.  More importantly, we prefer an undervalued currency.  For this is the lesson of the successful developing countries; an undervalued currency is a necessary condition to achieve sustained high-growth rates over a long period.  Empirical studies have confirmed this.  Dani Rodrik, for example, estimates that an undervaluation of 50 percent (which is roughly the undervaluation of the Chinese renminbi) translates into a contemporaneous growth boost of 1.35 percentage points.

In the past, an advocacy for an undervalued currency was a lonely battle. Devaluation has been associated with economic crises.  Thus, those who prescribe depreciation face what Fabella calls a “credibility wall.”

But precisely, devaluation was a corrective measure in light of the significant overvaluation of the peso.  We would not have been struck hard by the 1997 financial crisis, if the peso was not overvalued in the first place.

But this time, the public is learning that an appreciating, overvalued currency hurts the whole economy and many sectors.  Now, the media reports attribute the closure of 75 firms in the first half of 1997 and the displacement of 100,000 workers in the seaweed industry, to the appreciating peso.

There is now an expanding constituency, organized and articulate, for a competitive exchange rate, which is our euphemism for undervaluation. It is composed of the organizations of manufacturing exporters, food processors, business process outsourcing, workers, overseas Filipinos, together with public interest groups and academics.  Even the protectionists favor a devalued currency as a substitute for trade protection.  Even the enlightened importers favor a competitive exchange rate, for in the long-run, they will benefit from the growth of the economy’s real sector.

The Manila police force are of course welcome to join this alliance.