managing external risk by maintaining adequate international

Pananalaping Matatag, Bansang Panatag

Managing External Risk by Maintaining Adequate International Reserves

December 9, 2010

Mr. Alphew T. ChengOfficer-in-Charge

Treasury Department


Outline

I. Introduction

II. The Purpose of Maintaining International Reserves

III. Reserve Adequacy

IV. Conclusion


R.A. 7653: The New Central Bank Act (1)

Section 65: International Reserves — In order tomaintain the international stability and convertibility ofthe Philippine peso, the Bangko Sentral shall maintaininternational reserves adequate to meet anyforeseeable net demands on the Bangko Sentral forforeign currencies.

In judging the adequacy of the international reserves,the Monetary Board shall be guided by the prospectivereceipts and payments of foreign exchange by thePhilippines…

Introduction / Purpose / Adequacy / Conclusion


R.A. 7653: The New Central Bank Act (2)

Section 66: Composition of the International Reserves – The international reserves of the Bangko Sentral may include but shall not be limited to the following assets.

(a) gold; and(b) Assets in foreign currencies in the form of: documents and

instruments customarily employed for the international transfer of funds; demand and time deposits in central banks, treasuries and commercial banks abroad; foreign government securities; and foreign notes and coins.

The Monetary Board shall endeavor to hold the foreign exchange resources of the Bangko Sentral in freely convertible currencies…



IMF Definition

Reserve assets are external assets that are readily available to and controlled by monetary authorities

• Does not include: • Claims from residents

• Illiquid investments

• Non-convertible currencies



Reserve Composition

67%

18%

12%3%

Foreign Securities

Cash and Deposits

Gold

Others



Transaction Motive of Holding Reserves

• R.A. 7653

– To meet any foreseeable net demands on the Bangko Sentral for foreign currencies

• FX obligations

• FX transactions

• NG requirements



Insurance Motive of Holding Reserves

• R.A. 7653

– To maintain the international stability and convertibility of the Philippine peso

• IMF

– For direct financing of payments imbalances

– For indirectly regulating the magnitudes of such imbalances through intervention in exchange markets to affect the currency exchange rate



Asian Crisis of 1997

-4

-2

0

2

4

6

8

10

12

14

16

1992 1993 1994 1995 1996 1997 1998 1999

GIR

Level (in $ b) Change

-40%

-30%

-20%

-10%

0%

10%

20%

0

5

10

15

20

25

30

35

40

45

19921993199419951996199719981999

USD/PHP

Level % Change



Subprime Crisis of 2008

0

10

20

30

40

50

60

70

80

90

2006 2007 2008 2009 2010

GIR Forwards

GIR & Forwards(in billion USD)

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

36

38

40

42

44

46

48

50

2006 2007 2008 2009 2010

P/$ % Change

USD/PHP



Precautionary Motive of Holding Reserves

• IMF WP/01/143: “Reserves in various ratios with other economic variables have turned out to be a useful crisis predictor”

• IMF SPR Departmental Paper dated 6/15/10: “External sector indicators perform the best in predicting past crises”



Overall Vulnerability Index of the IMF



Credit Ratings

• S&P: Reserves/(Imports + Interest Payments)

• Moody’s: Reserves/Short-term external debt

• Fitch: Liquid external assets/Liquid external liabilities



Recent Upgrades in PHL Credit Ratings

• Moody’s 7/23/09 (B1 to Ba3):– “The upgrade was prompted by the relatively high

degree of resiliency exhibited by both the country’s financial system and external payments position in the face of the global financial and economic crisis.”

• S&P 11/12/10 (BB- to BB): – “We have upgraded the Philippines based on its

steadily improving external liquidity profile and underlying strengths of its external accounts.”



Gross International Reserves

0

10

20

30

40

50

60

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

(in billion USD, as of end-October 2010)



Balance of Payments

-4000

-2000

0

2000

4000

6000

8000

10000

12000

BOP(in million USD)

Current Account

Capital & Fin'l Account

Balance of Payments

Jan - Sept

2009 2010

Remittances 12,789 13,782

Growth rate (yoy) 4.2 7.8

Exports 27,649 38,298

Growth rate (yoy) (28.9) 38.5

Remittances & ExportsValue in US$ million; Growth rates in %


Commonly-used Reserve Adequacy Measures

• Reserves equal to short-term external debt (Greenspan-Guidotti rule)

• Reserves equal to three or four months of imports

• Reserves equal to roughly 5-20 percent of M2

Source: US Department of Treasury, “The Adequacy of Foreign Exchange Reserves.”



PHL GIR Ratios

GIR Ratio Benchmark end 1996 end 2007 Latest

ST Debt 1 1.6 3.0 5.6

Imports 3 to 4 mos. 4 7 12

M2 5% to 20% 35% 44% 60%



GIR vs. External Debt(in billion USD, as of end-June 2010)

0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

GIR External Debt



Diminishing Marginal Utility of ReservesIMF SPR Departmental Paper dated 6/15/10:



Costs of Holding Reserves

• Macroeconomic costs

– Opportunity Cost

– Inflation

• Financial Costs

– Sterilization Cost

– Exchange Rate Losses



Chiang Mai Initiative Multilateralization (CMIM)

• Multilateral agreement among ASEAN+3 members totaling USD120 billion

• Took effect on 24 March 2010

• FX swap vs. local currency

• Up to USD11.38 billion available for the Philippines



Regional ComparisonCountry GIR

(US$ Bio)GIR/GDP

GIR /ST Debt

Import Cover

GIR/M2

Philippines 57 23% 5.6 12 60%

Indonesia 92 11% 2.2 8 34%

Malaysia 105 48 % 3.1 8 31%

Thailand 171 50% 3.1 12 45%



YTD FX Movements

Currency Volatility (SD/Ave)

Appreciation

PHP 2.45 5.60

IDR 1.58 4.74

MYR 3.29 9.28

THB 3.51 11.06

(as of 06 December 2010, in %)



Conclusion

• Reserve accumulation is an important strategy to manage external risk

• The recent growth in the reserves will provide increased flexibility for the BSP to achieve its objectives

• The cost of holding reserves will be balanced against its benefits, as well as merits of other strategies



Thank You

managing external risk by maintaining adequate international

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