A futile rate hike

Why has the peso kept losing value even after the recent “jumbo” interest rate hike by the Bangko Sentral ng Pilipinas (BSP)? In theory, this would make peso-denominated assets more attractive to global investors chasing yields and curb domestic inflation. But why didn’t it arrest the slide? BSP Governor Eli Remolona Jr. is playing a valiant defense, but he knows full well that a currency’s value is ultimately a mirror of a nation’s structural and institutional health. The rate hike is like paracetamol given to a patient to break a fever: it treats the symptom, but does nothing to cure the deep-seated infection. Right now, the Philippine peso is bleeding from three distinct structural wounds that a jumbo rate hike simply cannot bandage.

First is our widening trade deficit (translation: we are spending more dollars for our imports than we are earning from exports). Because we depend heavily on imported energy and foreign farm inputs and products, any uptick in global commodity prices means we have to spend more dollars just to keep the lights on and our plates filled. This massive trade deficit swamps any speculative portfolio capital our high interest rates might attract.

Second, the market is playing a game of numbers with the BSP, and the market is winning. Traders see our gross international reserves thinning. This signals to currency speculators that the BSP’s ammunition for direct market intervention is limited. In this situation, a rate hike looks less like a position of strength and more like a defensive, rearguard action. Burning further through our hard-earned foreign exchange (forex) reserves is a dangerous, unsustainable dead-end, while interest rate hikes have hit a wall of diminishing returns.

Third, and possibly most crucial, we’re in the midst of a severe crisis of investor confidence fueled by a governance credibility gap. Financial capital is famously cowardly; it flees at the first sign of institutional decay. The flood control scandal cast a long shadow over our macroeconomic landscape. When global rating agencies and multilateral banks downgrade our economy’s growth outlook, global fund managers pay little attention to our otherwise attractive 5.5-plus percent interest rates. They see institutional risk and choose to park their money in safer harbors. No interest rate hike can compensate for a perceived breakdown in the rule of law.

So what can the economic team do? We need an immediate pivot to a coordinated fiscal and structural strategy. We must plug structural leaks, aggressively manage dollar flows, and restore institutional credibility. In the immediate term, we must prioritize imports. I don’t mean a return to protectionism, but a temporary, strategic rationalization of our dollar outflows, starting with the government’s large-scale, import-heavy infrastructure projects. Concurrently, we must cut red tape and clear logistical bottlenecks impinging on domestic food supply chains to lessen our reliance on emergency agricultural imports.

In the medium term, we need to tune up our capital flows management. We can’t afford to scare away future investment by imposing sweeping capital controls, but the BSP and the Department of Finance could use targeted incentives instead. We can make it highly lucrative, for example, for overseas Filipino workers and our business process outsourcing (BPO) firms to keep and compound their earnings within the domestic banking system. Tax-exempt, high-yield, dollar-denominated “Bagong Bayani Bonds” could channel billions in existing OFW earnings directly into productive domestic investments, and bypass the volatile open forex market.

On the fiscal front, the government could negotiate to restructure and extend maturities of our short-term, foreign-denominated public loans to smooth out our debt service payments and reduce the state’s sudden and massive spikes in dollar demand. But the real long-term cure is to upgrade our export structure. For too long, our export sector has relied on low value-added electronics assembly and basic services. We must pivot our electronics and BPO sectors toward higher-level, high-value products and sophisticated technical services. Climbing the global value chain will ensure that our export revenues grow faster than our import bills, and thereby tilt the balance of payments back in our favor.

Finally, and most urgently, we must address the governance deficit. The administration must convincingly restore confidence by demonstrating unwavering commitment to fiscal transparency. There are no ifs and buts about it. This means enabling independent, public audits of infrastructure spending and establishing ironclad guardrails against corruption. It’s only when investors are convinced that public funds are being safeguarded and institutional integrity is restored that capital flight will taper off, and the net outflow could be reversed. Good governance, as it turns out, is excellent currency stabilization policy.