Why the Philippine Peso's Strength Masks Underlying Vulnerabilities

  

If the governments devalue the currency in order to betray all creditors, you politely call this procedure 'inflation'--George Bernard Shaw 

In this issue

Why the Philippine Peso's Strength Masks Underlying Vulnerabilities

I. Philippine Peso in the Face of a Weak Dollar

II. Is the Peso’s Strength Rooted in Fundamentals? Portfolio Flows: A Mixed Picture

III. Remittances: Diminishing Returns

IV. Tourism: Geopolitical Headwinds

V. Trade Data: Structural Deficiencies Revealed

VI. Balance of Payments and Gross International Reserves: A Fragile Façade (Boosted by Borrowings)

VII. BSP’s Tightening Grip on FX Markets and the Illusion of Stability

VIII. The Speculative Role of the BSP: Other Reserve Assets

IX. Rising External Debt: A Ticking Time Bomb

X. Conclusion: Transitory Strength, Structural Fragility 

Why the Philippine Peso's Strength Masks Underlying Vulnerabilities 

A strong Philippine peso hides the cracks of FX debt, deficits, and interventions.

I. Philippine Peso in the Face of a Weak Dollar 

Figure 1

Surprisingly, the Philippine peso has outperformed its regional peers. Year-to-date, the USD-Philippine peso USDPHP has declined by 2.73% as of April 25. (Figure 1, upper window) 

Despite a generally weak dollar environment, the greenback has risen against some ASEAN currencies: it has appreciated by 4.32% against the Indonesian rupiah (IDR) according to Bloomberg data, and by 2.2% against the Vietnamese dong (VND) based on TradingEconomics data, year-to-date. 

The USDPHP’s behavior has largely mirrored the oscillations of the USD-euro $USDEUR pair and the Dollar Index $DXY, both of which have declined by -9.5% and -9% YTD, respectively. The euro commands the largest weight in the DXY basket at 57.6%, amplifying its influence over the index's performance. (Figure 1, lower image) 

II. Is the Peso’s Strength Rooted in Fundamentals? Portfolio Flows: A Mixed Picture  

Figure 2

Foreign portfolio flows have been volatile. 

The first two months of 2025 recorded a modest net inflow of USD 176.6 million, following significant outflows of USD 283.7 million in January and inflows of USD 460.34 million in February. These inflows were mainly directed towards government securities (USD 366 million), while the Philippine Stock Exchange (PSE) suffered USD 189 million in outflows. (Figure 2 topmost graph) 

In 2024, Philippine capital markets saw foreign portfolio inflows of USD 2.1 billion—the largest since 2013—suggesting a temporary vote of confidence, albeit in a risk-on environment favoring emerging markets more broadly. 

Meanwhile, the Bangko Sentral ng Pilipinas (BSP) reported that foreign direct investment (FDI) flows fell 20% year-on-year to USD 731 million in January 2025 from USD 914 million the year prior. (Figure 2, middle chart) 

Still, 71% of January’s FDI consisted of debt inflows, rather than equity investments. 

Ironically, despite the administration's aggressive international junkets (2022-2024) aimed at wooing investors through geopolitical alliances, these efforts have borne little fruit. 

What happened? 

As previously noted, an overvalued peso—maintained by a de facto USDPHP soft peg—along with high "hurdle rates" stemming from bureaucratic red tape and regulatory barriers, and the implicit consequences of "trickle-down" easy money policies benefiting the government and their elites (i.e., crony capitalism), have collectively undermined Philippine competitiveness. 

III. Remittances: Diminishing Returns 

Overseas Filipino Worker (OFW) remittance flows continue to grow, but at a marginal and slowing pace. Personal remittances rose 2.6% in February, with cumulative year-to-date growth at 2.7%. (Figure 2, lowest visual) 

However, the long-term trend in remittance growth has been declining since its 2013 peak—a period that coincided with the secular bottoming of the USDPHP. 

This trend reflects the diminishing marginal impact of remittances on the peso’s valuation. 

In short, remittances are becoming less material in influencing the peso’s foreign exchange rate. 

A more sustainable strategy would be to foster structurally inclusive economic growth—creating more high-quality domestic jobs and raising incomes—to reduce the country’s dependence on labor exportation and mitigate brain drain. 

Sadly, the slowdown in remittance growth does not point toward such an outcome. 

IV. Tourism: Geopolitical Headwinds

Figure 3 

The Philippine tourism sector's recovery may have stumbled. 

Foreign tourist arrivals fell by 2.42% in Q1 2025, while total arrivals—including overseas Filipino visitors—dropped by 0.51%. This was largely driven by a staggering 28.8% collapse in Chinese tourist arrivals in March and a 33.7% year-on-year plunge in Q1. This slump mirrors the escalating geopolitical tensions between the Philippines and China, particularly as Manila increasingly aligns itself with U.S. strategic interests. (Figure 3, upper diagram) 

Interestingly, American tourist arrivals also fell by 0.7% in March, although they rose by 7.9% for Q1 overall. Nonetheless, the growth in American tourists has hardly offset the sharp loss of Chinese visitors. (Figure 3, lower chart) 

In effect, a ‘war economy’ reduces the Philippines’ attractiveness as a tourism and investment destination. 

V. Trade Data: Structural Deficiencies Revealed

Figure 4

The Philippines' trade deficit narrowed by 11.44% to USD 3.16 billion in February, owing to a 1.8% contraction in imports and a muted 3.94% increase in exports, year-on-year. (Figure 4, upper graph)

While many mainstream talking heads argue that tariff liberalization will eventually benefit the Philippines, external trade figures tell a different story—one marred by structural weaknesses: high energy costs, a persistent credit financed savings-investment gap (a byproduct of trickle-down policies), the USDPHP peg, human capital limitations, economic centralization, regulatory hurdles and more.

Since 2013, total external trade (imports + exports) has grown at a CAGR of 4.84%—driven by imports growing at 5.95%, compared to exports at only 3.42%. Adjusted for currency movement (with the USDPHP CAGR at 3.01%), this yields a real export CAGR of just 0.41% versus 2.85% for imports, implying a real external trade CAGR of only 1.77%. (Figure 4 lower image)

While rising imports may superficially suggest robust consumption, a deeper question emerges: Is consumption fueled by genuine productivity gains—or by unsustainable credit expansion?

Ultimately, the data show that import-driven consumption has widened the trade deficit, and that local manufacturing remains largely uncompetitive relative to regional peers.

Against this backdrop, how realistic is it to expect that Trump's proposed tariffs will magically turn the Philippines into an export hub?

VI. Balance of Payments and Gross International Reserves: A Fragile Façade (Boosted by Borrowings)

Figure 5

The BSP reported a Balance of Payments (BoP) deficit of USD 2 billion for March 2025, following a staggering USD 4.1 billion deficit in January—an 11-year high—and a temporary surplus of USD 3.1 billion in February. The Q1 2025 BoP deficit stood at USD 2.96 billion. (Figure 5, upper window)

The BSP attributed these outflows to "drawdowns on reserves to meet external debt obligations" and to fund foreign exchange operations—justifications previously offered for January’s record deficit.

Meanwhile, February’s surplus largely stemmed from net foreign currency deposits by the National Government, sourced from proceeds of ROP Global Bond issuances and income from BSP’s foreign investments—in other words, from external borrowings.

Notably, the BSP has admitted that the year-to-date BoP deficit mainly reflects the widening goods trade deficit. Either this conflicts with PSA trade data showing a narrowing February deficit, or it hints at a possible sharp deterioration in March's trade balance.

Regardless, the BoP reports clearly indicate heavy BSP intervention in the FX market, even though the USDPHP remains well below the 59-level psychological ceiling.

Consequently, the BSP’s gross international reserves (GIR) dropped from USD 107.4 billion in February to USD 106.7 billion in March—a USD 725 million decline. (Figure 5, lower diagram)

Importantly, much of the GIR’s support comes from the government’s external borrowings deposited with the BSP. Thus, the GIR has been padded up artificially.

Figure 6

Even more striking: gold’s record high prices have prevented a steeper GIR decline, despite the BSP selling small amounts of gold in February.  

Gold's share of GIR slipped marginally from 11.4% in February to 11.22% in March. (Figure 6, upper pane)

Had it not been for ATH (all-time high) gold prices, the GIR would have deteriorated more significantly. 

As previously explained, as with the 2020 episode, sharply falling gold inventories preceded the devaluation of the peso. (Figure 6, lower chart) 

Outside of gold, a large share of GIR now constitutes "borrowed reserves"—a growing vulnerability tied directly to the BSP’s soft peg strategy for the USDPHP. 

This suggests that the recent GIR stability could be masking underlying vulnerabilities.

VII. BSP’s Tightening Grip on FX Markets and the Illusion of Stability 

It is therefore almost amusing to encounter this news item, based on the BSP’s publication: 

Inquirer.net, April 24: "The Bangko Sentral ng Pilipinas (BSP) tightened regulations on foreign exchange (FX) derivatives involving the Philippine peso to ensure these are not used for currency speculation. Circular No. 1212, signed by Governor Eli Remolona Jr., mandates that banks authorized to transact in non-deliverable FX derivatives must ensure these are used for legitimate economic purposes." 

But who are the likely participants in FX swaps, non-deliverable forwards, and FX derivatives?

Not me. Not the general public. 

Given that PSE participation is only around 1% of the total population (as of 2023), the obvious answer is: banks and their elite clientele—the BSP’s own cartel members. 

Thus, what is the real message behind this announcement? 

First, banks and their elite clients may have been positioning against the peso, in ways inconsistent with BSP policy—prompting the BSP to tighten currency controls. 

Second, the BSP wants to show the public it is taking action, even as real risks accumulate. 

Third, something is amiss if the BSP feels compelled to impose tighter controls even with the USDPHP hovering at 56—well away from their upper band limit. 

Ultimately, who is truly engaged in currency speculation here? 

VIII. The Speculative Role of the BSP: Other Reserve Assets

Figure 7

Since 2018, the BSP has increasingly used Other Reserve Assets (ORA) to manage its GIR. (Figure 7) 

According to IMF IRFCL guidelines, ORA includes:

-Net, marked-to-market value of financial derivatives (forwards, futures, swaps, options)

-Short-term foreign currency loans

-Long-term loans to IMF trust accounts

-Other liquid foreign currency financial assets

-Repo assets 

The BSP’s ORA surged by 210.3% in February, lifting its share of GIR to 9.18%. Yet, even this rise was overshadowed by gold's role in preserving GIR totals. 

In truth, the BSP itself is a speculator—aggressively managing USDPHP levels against market forces. 

In pursuing short-term stability, it risks building imbalances that will eventually unwind with greater force. 

This has been evident in the widening BoP deficit, the rising share of "borrowed reserves," and the sustained gold sales. 

IX. Rising External Debt: A Ticking Time Bomb

Figure 8

Perhaps most revealing is this BSP announcement: 

BSP, April 25, 2025: "The Monetary Board approved USD 6.29 billion worth of proposed public sector foreign borrowings in Q1 2025, up by 118.91% from USD 2.87 billion during the same period last year." (bold mine) [figure 8, upper graph] 

Whatever the justification—whether for infrastructure, green (climate), defense, or welfare or others—debt is debt. 

Even though the BSP paid down nearly half its obligations (posting a Q1 BoP deficit of USD 2.96 billion), the residual balance should add to the swelling external debt stock. (Figure 8, lower chart) 

Recall that as of Q4 2024, government debt already accounted for 58% of total external debt. Banks and non-finance institutions are likely to add to this pile. 

Higher public debt implies higher future debt servicing costs, crowding out resources from productive investments, draining savings, increasing leverage, and deepening the Philippines’ dependence on foreign financing. 

X. Conclusion: Transitory Strength, Structural Fragility 

The Philippine peso’s strength in 2025, buoyed by a weak U.S. dollar, masks underlying vulnerabilities. Structural issues—overvalued currency, uncompetitive manufacturing, declining remittance growth, geopolitical strains, and reliance on borrowed reserves—undermine long-term stability. 

Through the USDPHP soft peg, the BSP’s interventions, while stabilizing the peso in the short term, foster imbalances that could unravel with a global tightening of monetary conditions. 

Without addressing these structural challenges through inclusive growth, deregulation, and reduced dependence on debt and remittances, the Philippines risks a rude awakening. The peso’s current resilience is less a reflection of economic strength and more a temporary reprieve, vulnerable to shifts in global financial tides. 

Nota bene: Although we discussed tourism and remittances, we did not cover business process outsourcing (BPO) and other export services in depth, largely due to limited data and the need to rely on GDP proxies. Regardless, surging debt levels are exposing widening FX liquidity vulnerabilities that services alone cannot offset. 

____

reference 

IMF INTERNATIONAL RESERVES AND FOREIGN CURRENCY LIQUIDITY GUIDELINES FOR A DATA TEMPLATE 2. OFFICIAL RESERVE ASSETS AND OTHER FOREIGN CURRENCY ASSETS (APPROXIMATE MARKET VALUE): SECTION I OF THE RESERVES DATA TEMPLATE, p.25 IMF.org

 

Risks from Italy and Austria’s Elections

Today, residents of Italy and Austria will vote.

Since the Philippines is 7 hours ahead of Italy and Austria, by the time you read this, the Italian referendum and Austrian presidential election may be at its conclusion or may have already closed.

The outcome of the both will likely be crucial to the survival of the European Union, and consequently, its key monetary institution, the European Central Bank.

Austria’s presidential election represents a re-voting of the May “second runoff” election that has been annulled due to irregularities and fraud.

In May, the populist right wing anti-immigration Freedom Party (FPO) narrowly lost with 49.65 percent of the vote. And this was prior to UK’s June 2016 Brexit.

UK’s Brexit and the Trump phenomenon appears to have ushered a geopolitical movement towards the “far right” nationalism that is likely to threaten EU’s existence. 

It is widely speculated that the FPO’s victory could likely entail an exit by Austria from the EU.

Austria ranked ninth in terms of (2015) GDP in the EU.

The far bigger concern will be the Italian elections. Italy is the fourth largest EU economy.

Despite the political-institutional repercussions, today’s referendum has essentially been about a confidence vote on the incumbent Prime Minister Matteo Renzi government.

As Italian economist Alberto Mingardi described (Econolog; December 3. Bold original): “In actual fact, the constitutional reform we're going to vote on implies by no means a drastic change in our political governance. It changes the role and the composition of the Italian Senate, without sweeping it away; it re-centralizes powers from regional governments; it fine tunes the legislative process to fit the new context. It doesn't increase the powers of the prime minister, or give him the power to dissolve parliament. Mr Renzi claims the new reform will allow for faster and thus more productive law making, but it's hard to argue that Italy has a shortage of laws… This is because the referendum has by now little to do with the essence of the constitutional modifications approved by Parliament and now put to the voters: Italians will be voting for or against the Renzi government.”

And post referendum environment will be pivotal, again Mr. Mingardi: (bold mine) “What I personally find more problematic is the sort of political equilibrium that would emerge after the referendum's result. MrRenzi has approved, during his tenure, a new electoral law with a majority bonus system. However, this electoral law applies only to the House of Deputies, on the assumption that the Senate was changed by the constitutional reform into an indirectly elected organ, representing local governments. If the "no" side wins the referendum, then Italy will have two very different electoral laws, an old one for the Senate and a new one for the House. Both the chambers are supposed to give the government a confidence vote. This is why, if the no wins, there would be no immediate elections before a new electoral law, applicable to both the chambers, is enacted. If the no side wins, moreover, this will be widely considered a triumph of the populist Five Stars Movement, a heterogeneous political force that brings together an emphasis on transparency and the fight against corruption with a strong anti-business and anti-capitalism attitude.

A tenuous aftermath, again Mr. Mingardi: “Even Renzi's enemies will freak out at the perspective of the Five Stars Movement winning the next election. This is why it is very likely that the new electoral law that "establishment" parties are more likely to agree on is a pure proportional representation system.  Is that a brilliant idea? As the likelihood of any party winning a clear majority of the votes is astonishingly small, this would make Italy a country run by a permanent grand coalition between the right and the left, with the sole purpose of keeping the Five Stars at bay. In such a context, however, everybody tries to avoid the negatives for their own constituency, instead of forgoing vetoes and negotiating reforms. This would decrease and not increase the likelihood of reforms being approved, with perhaps the unintended consequence of strengthening the Five Stars Movement even further.

In short, the populist Five Stars Movement is about to gain power.

It’s not just politics.

Italy’s banking system has been experiencing tremendous difficulties. But thanks to the ECB’s QE (Large Scale Asset Purchases), such actions have delayed it from a total crisis. As proof, despite NPLs at approaching 20% of GDP, estimated at 360 billion euros ($401 billion) or bad debts equal to 12% of total loans, Italy’s 10 year sovereign yield hit a record low of 1.04% last August! That’s the kind of lunacy—utter destruction of price discovery—that has been brought upon by central bank policies. This means that Italy’s credit risk has essentially evaporated!

During the window provided by the ECB, the Renzi government has been working steadfastly for a rescue on Italy’s banks, particularly, the world’s oldest bank and Italy’s third largest, Monte dei Paschi.

Now a loss by the Renzi government would undermine such rescue effort. From Reuters (November 28): “Fears that a Renzi defeat at the referendum could sink Monte dei Paschi's recapitalization plan and have a domino effect on other lenders - including another seven already in trouble”.

So once again, the ECB reportedly will come to its rescue by buying MORE Italian bonds, should the referendum’s outcome unleash mayhem (Reuters November 29).

In short, Italy’s politics have been deeply entwined with its banking and economic rut.  And a “NO” outcome would postulate that all these years of “kick the can down the road” would meet its natural real world limits. Said differently, while central banks have successfully manipulated financial markets to shield them from their natural economic consequences during the past years, real world events have begun to neutralize such market destruction process.

Actions have consequences. Destruction of money has its consequences too.

 

Elections are about people expressing their political choice through political means. But more important is the expression of people’s actions through money. 

Italy has been experiencing a tsunami of capital flight as shown by ECB’s Target2 or the real-time gross settlement for the clearing of cross-border transfers in the Eurozone.

As Harvard economist and co-author of “This Time is Different”, Ms. Carmen Reinhart wrote in the Project Syndicate (November 23) [bold mine, see chart above]: “If interest rate hikes, depreciation or devaluation of the currency, and controls on financial outflows are not viable options, what can a country’s central bank do when faced with accelerating capital flight? If it is not part of a currency union, it can resort to market intervention to support its currency, using and losing its foreign-exchange reserves in the process. Saudi Arabia’s massive reserve losses in the wake of falling oil prices reflect this policy response. Within theeurozone, such reserve losses are automatic under Target2, the real-time gross settlement system for the euro. If a country has run out of reserves, its central bank automatically borrows to maintain the intraeuro peg. For a country experiencing capital flight (as much of the eurozone periphery has at various points since 2008), this implies a progressively more negative Target2 balance. As of September (the most recent data available), Italy’s Target2 deficit is above 20% of GDP – its worst reading to date (see figure). By some of the standard definitions, these are crisis-level reserve losses(shaded in the figure).

The Italy’s Target2 outflows in October had been much smaller at € 1.6 billion compared to € 27 billion in September. But this may be calm before the storm.

The above only goes to show that regardless of the outcome of the elections, the Italians have already been voting—and that their money votes imply of a “crisis-level reserve loss”.

The capital flight of crisis proportions may have been about the banking crisis or about the Renzi confidence referendum or most likely both. 

While a “yes” result may defer the stampede out of Italy, it will unlikely solve political, economic and financial predicaments without allowing the markets to work. Imbalances will only continue to mount.

Yet the ECB has bought the Italian government significant time for its banking system and the government to reform to no avail. That because low rates only served as a moral hazard for government to reform. Why reform if central banks can keep the status quo?

Now the proverbial chicken has come home to roost. A “NO” vote will most likely accelerate such exodus, perhaps regardless of what the ECB does.

Yet despite the ECB’s announcement to support Italian bonds, the irony has been that the ECB has been in caught in a dire fix: Asymmetric policies by global central banks and an internal predicament—the growing lack of bond market liquidity via the dissipation of available bonds by the ECB to purchase.

From the Financial Times (November 30. Bold added): The calendar is not kind to the European Central Bank. A week on Thursday, its governing council will deliberate, just days after Italy’s vote on constitutional reform, and a week before the bank’s US counterpart holds a meeting which could move the world’s bond and currency markets. Temporal pressure of another kind is also building, as the ECB buys €80bn of bonds each month in a programme that runs until March. Extending it could create a new problem, as there may not be enough German Bund’s available next year to keep the ECB’s spending on the eurozone member country’s debt in line with a carefully agreed formula.

And if I’m not mistaken, the ECB has been signaling its implicit intent to “taper” by citing (bubble) risks from its current policies.

From Reuters/Japan Times (November 30): The residential property market risks overheating in eight European Union countries, including Britain, partly from unintended effects of ultra-low interest rates, the EU’s financial risk watchdog said on Monday. The eight countries face a medium-term risk either from overvaluation or excessive household debt levels, a systemic risk to the bloc’s financial stability that requires regulatory attention, the European Systemic Risk Board said in a report. The ESRB issued warnings to Austria, Belgium, Denmark, Finland, Luxembourg, the Netherlands, Sweden and Britain. It asked local authorities to devise appropriate measures and noted the vulnerabilities of banks in an environment of persistently low interest rates. “Household indebtedness and the overvaluation of residential real estate develop over the course of years,” ESRB chair and European Central Bank head Mario Draghi said while presenting the report to an EU parliamentary committee.

Has there been an epiphany for Mr. Draghi??? Has Mr. Draghi been signaling to taper???

If he is, then just what would happen to Italy’s banking system??? What would happen to EU’s property bubbles??? And what would happen to EU’s political and financial system that had become almost entirely dependent on the ECB’s low rates????

Yet it doesn’t even require Mr. Draghi to act, because increasing imbalances are presently being ventilated via politics and through the balance sheets of the government and financial institutions…to the point that the ECB has begun admitting to this.

And consequences from these would be confined to Europe?????

The more interesting part has been for stock markets to rationalize present geopolitical developments as fodder for panic bidding.

Initial anxieties were revealed in Brexit and in the US national elections (or even the Philippines presidential elections). However, the paradox has been that conclusions to these events had been justified for a blowoff phase or a meltup.

And because of complacency developed, unfolding events in Europe appear to have been being discounted.

Sometime very soon these misperceptions will face reality.

Yes, actions have consequences. And I’m reminded by this treasure.

From John Maynard Keynes (PBS)

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth.

Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become "profiteers," who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.