Reserves for the future

OF SUBSTANCE AND SPIRIT

Smart households set aside some contingency funds, whether in cash or in bank deposit. It’s a precaution which may sound costly but the peace of mind that it buys is priceless. It’s no different for the sovereigns, but it’s their central banks or treasuries that keep their contingency funds as gross international reserves (GIR) or foreign exchange (FX) reserves. In the BSP statistics, one finds GIR listed as total foreign assets.

As the Philippine economy gained stronger footing in over 20 years prior to the pandemic of 2020, the country’s FX reserves started to surpass its level of external debt a few years after the Global Financial Crisis (GFC) of 2008-2009, exceeding normal metrics of debt capacity and credit worthiness. For it was during the GFC when the US and Europe went unconventional, unorthodox in its conduct of monetary policy by setting their policy rates close to zero. As a result, foreign funds crossed borders and parked in many emerging markets including the Philippines where interest rates remained generally normal.

Philippine GIR climbed by leaps and bounds beginning in 2006 when they rose from $18.5 billion in 2005 to nearly $23 billion. Thereafter, the rise was just phenomenal until 2011 when they hit over $75 billion and went fast our external debt of $66.1 billion. For the next 10 years, we accumulated FX much more than we borrowed as a nation.

At the end of 2021, GIR tipped the scale at $108.8 billion, close but still ahead of the overall external debt level of $106.4 billion.

Thus, last Monday’s report of the broadsheets that the “country’s FX buffer slipped for the seventh straight month to $95.01 billion in September from the revised $97.44 billion in August” was quite oblique. While it was correct to relate the GIR level to imports and short-term debt, the business reporters could have made some additional points like the decline of the GIR lower than the June 2022 overall external debt of $107.7 billion.

In all the nine months of 2022 except February, the FX reserves never recovered from the end-2021 level, while our foreign debt, because of budgetary requirements, used and wasted, just skyrocketed. Its level increased precipitously from $83.6 billion in 2019 to a whopping $98.5 billion in 2020 and $106.4 billion in 2021. As of June 2022, our foreign debt summed up to $107.7 billion.

Obviously, we should not limit our reserves monitoring to only the movement in foreign assets relative to our external debt, both overall and short term. Foreign investors and credit rating agencies are also monitoring potential drains in FX reserves and precisely, this is part of the surveillance process of the Fund. Focus is also given to foreign portfolio investments and monetary aggregates which are both potential liabilities. In the Philippine case, other sources of FX earnings should be assessed including overseas remittances and revenues from outsourcing business.

It’s not as easy as saying our GIR are adequate to cover nearly eight months of imports of goods and payment of services, or seven times our short-term debt based on original maturity, or four times based on residual maturity. There are more volatile potential drains on GIR such as capital flight that might be driven by political instability or policy uncertainty, or terms of trade due to volatile global markets.

This is how the IMF decided to devise a way to assess reserves adequacy of its member countries, knowing fully well the importance of holding prudent reserves, and reduce the likelihood of any external payment crisis. This is ranged against the opportunity cost of holding reserves beyond what may be considered to be adequate. This type of assessment could be challenging because quantifying risks and vulnerabilities is rather complex and tricky, and thus, nuancing the assessment according to specific characteristics and circumstances of each member country is crucial. No one size fits all.

This measure covers 78 emerging market economies from 2000 to present, and represents the consolidated learning from policy papers of 2011, 2013, and 2015. For analytical purposes, adaptive adequacy assessments have been applied on three types of economies: mature markets, deepening financial markets and credit-constrained economies.

What do these assessments yield for the Philippines?

Comparing the country’s GIR and the Fund-computed level of GIR considered to be adequate based on both reserves fund use and potential drain, the country’s GIR of 2010 and 2021 were not too dissimilar.

At only $62.4 billion in 2010, the GIR was 2.36 times higher than the ARA metric. At that level, our FX reserves were enough to cover nearly six times our short-term debt based on original maturity or four times based on residual maturity. The level recorded an import cover of 10.4 months.

Our FX reserves closed 2021 with $108.8 billion, the ratio with the ARA metric coming down to 2.3. Their coverage of short-term debt based on original and residual maturities inched higher to seven times and five times, respectively. But their import cover declined to 9.7 months.

All up, it looks like we have more than enough reserves for contingency purposes. True, when one has more than enough in his pockets, it would be tempting to go into investment. A few years ago, that idea came from some quarters to create a sovereign wealth fund (SWF) out of the BSP’s FX reserves. If $95 billion represents 2.3 times what is adequate, then some people would argue that we need no more than $41.3 billion in reserves. Lest it be forgotten, reserves by law are reserves for the future. Its use is appropriately restrictive.

Next week: More on reserves, sovereign wealth fund and unused budget