FX volatility has no long-term negative impact on PHL growth

Exchange rate volatility does not appear to have a long-term negative impact on Philippine economic growth, a study by the Bangko Sentral ng Pilipinas (BSP) showed.

In a discussion paper titled “Does Exchange Rate Volatility Matter for Economic Growth,” BSP researchers said exchange rate volatility can lower growth in some economies like the Philippines, but only in the short term.

“In the short run, exchange rate volatility exerts a negative impact on some economies and a positive impact on others. A percentage change in exchange rate volatility decreases economic growth by about 0.14% in China, 0.19% in Singapore, and 0.4% in the Philippines,” the BSP researchers said.

The study tackled the effects of volatility in the foreign exchange (FX) markets of 11 Asia-Pacific economies from 2002 to 2022.   

However, this negative impact on economic growth in China, the Philippines, and Singapore dissipated in the long run, BSP researchers said.

“This may imply that measures used by these economies to respond to exchange rate volatility could be effective and that other factors are more important for economic growth in the long run,” they said.   

One of the most known episodes of FX volatility in the Philippines occurred last year, when the peso hit a record low of PHP 59 against the greenback in October, amid the US Federal Reserve’s aggressive tightening.

The BSP hiked policy rates to avoid a narrower interest rate differential with the US Fed and used its dollar buffers to mitigate the volatility in the foreign exchange market.

From March 2022 to June 2023, the Fed raised its key rates by 500 basis points (bps) to 5-5.25%, while the BSP hiked by 425 bps to 6.25% from May 2022 to March 2023.

Volatility
Also, the BSP study showed the Philippines’ average exchange rate volatility at 4.898 between 2002 and 2022, which is below the East Asia and Pacific average of 6.162.

New Zealand (11.622) had the highest average exchange rate volatility, followed by Australia (10.933), Japan (9.001), South Korea (8.412), Indonesia (6.541) and the Philippines.

Hong Kong, on the other hand, had the lowest exchange rate volatility since it adopts a linked exchange rate system.

BSP researchers said most economies experienced the highest volatility during the global financial crisis in 2008.

“In the case of the Philippines, heightened exchange rate volatility has a positive impact on real GDP growth, possibly implying that exchange rate policies that are in place to address volatile movements of peso-dollar rate and that changes in the exchange rate help the economy respond to long-term shocks,” the study said.   

The exchange rate policy in the Philippines is a free-floating exchange rate system where the BSP leaves the determination of the exchange rate to market forces. Thus, the BSP’s intervention in the FX market is limited to tempering sharp fluctuations.

In the event of excessive volatility, the BSP enters the market to maintain stability. The BSP also stands ready to provide some liquidity, ensuring that legitimate demands for foreign currency are met. 

BSP researchers also said the results offer implications for the implementation of monetary policy.   

“A component of monetary policy implementation has been the approach of many Asian economies to use varying methods of sterilization to absorb the liquidity created by FX intervention, thus maintaining monetary independence,” they said.   

Sterilization is a form of monetary action in which a central bank seeks to limit the effect of inflows and outflows of capital on the money supply.

The study noted there were 914 sterilization episodes observed in the Asia-Pacific economies from January 2002 to December 2022. Hong Kong and Indonesia recorded the fewest episodes of sterilization, while the Philippines and Thailand showed the highest number of sterilization episodes   

“An important contribution of this study in the literature is that it provides evidence that exchange rate volatility is not necessarily deleterious to economic growth,” the BSP researchers said.   

The results also suggest that the participation of central banks in the FX market has been largely successful in mitigating the negative effects, while other factors are more important for economic growth, not just the FX rate.   

“Findings imply that when there is exchange rate volatility, authorities must be circumspect on whether to release policy tools to manage the volatility or let the exchange rate be volatile and perform its role as a shock absorber,” researchers said.

The study was written by Hazel C. Parcon-Santos, Veronica B. Bayangos, John Michael Rennie G. Hallig, Neil Fidelle G. Lomibao and Irene Rose Imson, all researchers of the BSP Research Academy. — By Keisha B. Ta-asan