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Webfiles: Don't Even Think About It

Capital controls are not the answer for the Philippines

By ASSIF SHAMEEN

Friday, August 10, 2001
Web posted at 08:00 p.m. Hong Kong time, 08:00 a.m. GMT

Philippine President Gloria Macapagal Arroyo's recent trip to Malaysia earned her a new nickname in Malaysia -- Gloria binte Mahathir Mohamad. To be called the daughter of Malaysian strongman might even flatter a woman who has been saying for months that for her Mahathir was a "role model." On Aug. 9, Arroyo made it clear what she really admired about the 73-year old Malaysian helmsman was his guts to stand up to currency speculators and his policy of capital controls. She even issued a warning to currency speculators that she was considering imposing Malaysian-style capital controls. "I don't envision, it but I don't want to rule it out -- so speculators be forewarned."

That put the business community in a flap, and analysts are already wondering aloud what the measures might do to the Philippine economy in the longer term. So much so that Central Bank governor Rafael Buenaventura had to do some damage control in the hours after the president's statement was flashed around the world on trading screens. Buenaventura said the peso would remain "market determined," though he reiterated that capital controls were an option "always available" to the government.

Arroyo hasn't specifically talked about the level of any peso peg, but she has said in the past that she believes the fundamental value of the Philippine currency should be around 50 to the dollar. Until she arrived in Kuala Lumpur, the peso was trading at nearly 54 to dollar -- not far off its lowest point earlier this years in the dying days of president Joseph Estrada's rule.

I believe a currency peg would a be huge mistake for the Philippines -- as well as for any other Southeast Asian country that might be contemplating taking the Kuala Lumpur route. Thailand's Prime Minister Thaksin Shinawatra has talked about some form of currency control and is known to be a big admirer of Mahathir. Indonesian bureaucrats too have talked about capital controls and a peg. President Abdurrahman Wahid resisted the temptation, but it is still early days to predict what his successor, Megawati Sukarnoputri, will do.

There are plenty of reasons for Arroyo to tell her advisers to take a hike if say to her, "Look, Ma'am, how well Mahathir has managed his own currency controls." The Philippines is no Malaysia. And Arroyo is no Mahathir, no matter how much she might admire him. She should certainly avoid becoming his clone. A strong peso would hurt Philippine exports and the manufacturing sector at a time when the country needs to export its way out of trouble. A strong peso would make the Philippines less competitive and drive more foreign direct investments away to places like China at a time when Manila desperately needs new investments to boost its economy and battle rising unemployment. What's more, the Philippine does not have the sort of reserves to defend a peg at, say, 50 pesos to the dollar. The Philippines has a huge fiscal deficit, a low savings rate and, at 6.8%, one of the highest inflation rates in a region that is struggling with deflation.

A country can have a fixed exchange rate if it has its fiscal deficit under control and doesn't have a huge balance of payments problem. Malaysia was already raking in a trade surplus and a current account surplus when it imposed its controls. The Philippines is currently in the market for up to $1 billion in sovereign bond for its urgent financing needs. External debts are nearly $60 billion, with debt servicing nearly 20% of exports. Capital controls will hammer sovereign debt ratings and make it difficult to borrow money -- not just for the government but also for the private sector. Already, analysts are predicting economic growth this year will slow to under 1.5% from 4% last year and 3.4% in 1999.

And there's another problem: Once the controls are in place, how would they be implemented? It would require an even more bloated bureaucracy and, given the level of corruption, some people will almost certainly turn to bribes. What's more, there would be slippages and a black market would develop for U.S. dollars. All in all, the controls will create a bigger mess than exists now.

For the moment, the peso has strengthened, closing Aug. 10 at under 52 to the dollar for the first time since late April. Philippine banks and companies who were holding short positions on the peso scurried to wind down their positions, and that contributed to the strengthening. A slight appreciation of the yen and the Singapore dollar also helped.

Arroyo says she is trying to tackle peso speculators. Mahathir attacked foreign speculators and hedge funds when he erected those huge walls for his own Fortress Malaysia. Hedge funds are really no longer big players in currency markets and certainly not even bit players in Asia. The biggest speculators have been Philippine companies hedging against a falling peso. One wonders whether speculator is just a term used by a government that feels helpless in a volatile currency market.

Whatever Arroyo does, she must avoid Malaysian-style currency peg and controls. A Fortress Philippines would set back the country not one or two years but perhaps a decade or more. Capital controls will send a wrong signal to the international community at a time when Arroyo is still trying to put together a coherent policy to ride the cyclical downturn and when she has yet to start tackling most of the economy's structural problems. Though it is been a regional economic laggard, the Philippines has had a generally liberal and open regime. It doesn't need to imitate Malaysia.