Dollarization in the Philippines:The way in; the way out

Cayetano W. Paderanga Jr.Okinawa, Japan

8 April 2005

Outline

I. Determinants of dollarization

II. Dollarization and the growth of the financial sector

III. Dollarization, sudden stops & economic consequences

I. Determinants of dollarization in the Philippines

Background:- In 1970 Peso’s exchange rate was allowed to “float”- During the late 1970’s, monetary authorities allowed

foreign currency denominated deposits in offshore banking units of foreign banks and foreign sections of local banks

- The Philippine Dealing System was introduced in the late 1980s

- Full deregulation of foreign exchange earnings was fully accomplished in 1992

The Philippines has experienced two large foreign

exchange episodes in the last 20 years

ASEAN GDP Growth 1970-2004

-10.0

-5.0

0.0

5.0

10.0

15.0

1970 1975 1980 1985 1990 1995 2000

PHI

Average (w/o PHI)

Government deficits were substantial during the 1980s and the current account deficit worsened

Sudden stop: Capital flowed out of the ASEAN countries during the Asian Crisis. In case of the Philippines, capital flows also dropped in 1983.

ASEAN5 Current Account 1981-2003

-10,000.0

-5,000.0

0.0

5,000.0

10,000.0

15,000.0

20,000.0

1981 1986 1991 1996 2001

Year

PHI

Average (w/o PHI)

Capital Flows in the Philippines and the ASEAN

-15000

-10000

-5000

0

5000

10000

15000

1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003

Philippines ASEAN

- Although inflation rate has dropped significantly, dollarized deposit ratio still persist

- Inflation rates rose substantially during the 1980s

ASEAN5 Inflation Rate 1970-2004

-10.0

0.0

10.0

20.0

30.0

40.0

50.0

1970 1975 1980 1985 1990 1995 2000

PHI

Average (w/o PHI)

Dollar Deposits and Inflation, Philippines

0

5

10

15

20

25

30

35

40

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003-10

0

10

20

30

40

50

Percentage of dollar deposits Inflation rate

Almost 50 percent of the total NG debt are foreign currency denominated, 60 percent of which are in US$ …

National Government Outstanding Debt(in million pesos)

TOTAL 2,815,468 3,355,108 3,811,954

66.7% 72.6% 73.4%

Domestic 1,471,202 52.3% 1,703,781 50.8% 2,001,220 52.5%Direct Liabilities 1,462,950 1,701,484 1,998,926 Assumed Liabilities 8,252 2,297 2,294

Foreign 1,344,266 47.7% 1,651,327 49.2% 1,810,734 47.5%Direct Liabilities 1,334,451 1,643,342 1,804,942 Assumed Liabilities 9,815 7,985 5,792

Source: Bureau of Treasury

2002 2003 2004

NG debt as a fraction of nominal GDP

Foreign Debt Composition by Type of Currency

(in percent)

2002 2003 2004

US dollar 58.1 58.5 60.1

Japanese Yen 32.9 31.2 29.5

Euro 3.7 5.3 5.5

French Franc 0.5 0.5 0.5

Deutsche Mark 0.3 0.2 0.2

Other Currencies 4.5 4.3 4.2

Source: Bureau of Treasury

Foreign Currency-Denominated Loans and Deposits

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 20030

50

100

150

200

250

300

350

Loans and Discounts (Net) Deposit Liabilities Loans- to-deposit ratio,%

1985

1996

19971991

1983

• Dollarization accelerated starting 1992 to 1996. This is partly explained by the full deregulation of foreign exchange earnings in 1992.

• The post-crisis period saw a steeper decline in FCDU loans, relative to decline in deposit liabilities, as domestic borrowers shifted away from this type of loan in favor of local currency borrowings to minimize foreign exchange risk.

Deposit Dollarization

0

10000

20000

30000

40000

50000

60000

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

FCDU P eso Dominated Deposit

9

219 13 12 14 14 16

3118

21 2224

25 23

30 29 35 31 313028

The numbers denote the ratio of FCDU to total deposits (in percent)

4

II. Dollarization and the growth of the financial sector

Banking Assets and Deposit Dollarization

-60.00

-40.00

-20.00

0.00

20.00

40.00

60.00

80.00

100.00

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003YO

Y G

row

th R

ates

Deposit Money Banks Assets "Dollar" Deposits

1983

1985

1991

1996 1997

BSP GIR and Deposit Dollarization

-60.00

-40.00

-20.00

0.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

1 982 1 983 1 984 1 985 1 986 1 987 1 988 1 989 1 990 1 991 1 992 1 993 1 994 1 995 1 996 1 997 1 998 1 999 2000 2001 2002 2003

YO

Y G

row

th R

ates

BSP Gross Reserves "Dollar" Deposits

1983

1985

1991

1996 1997

III. Dollarization, sudden stops & economic consequences

1. Effects on the banking & corporate sector1. Asset-liabilities mismatch – currency risk masquerading

as credit risk2. Sudden stop leads to capital adequacy & balance sheet

effects2. Dollarization & government debt

1. Foreign liabilities of government held by domestic banks2. Fiscal deficits, ratings downgrades & balance sheet

effects3. Banking contraction leads to credit crunch

Growth of Bank Assets vs. Dollar Loans and Discounts T=1984

-60.0

-50.0

-40.0

-30.0

-20.0

-10.0

0.0

10.0

20.0

30.0

40.0

T-2 T-1 T T+1 T+2 T+3 T+4 T+5

Bank Assets g.r.

Loans and Discounts (Net) g.r.

Growth of Bank Assets vs. Loans and Discounts T=1997

-40.0

-20.0

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

T-5 T-4 T-3 T-2 T-1 T T+1 T+2 T+3 T+4

Bank Assets g.r.

Loans and Discounts (Net) g.r.

Bank Assets and Dollar Loans and Discounts

Dollarization and Capital Flow s: 1984 Episode

-1000

-500

0

500

1000

1500

2000

2500

3000

3500

T -3 T -2 T -1 T T +1 T +2 T +3

0

200

400

600

800

1000

1200

1400

1600

1800

2000

Capital Inflow Dollar Deposits

Dollarization and Capital Flow s: 1997 Episode

-6000

-4000

-2000

0

2000

4000

6000

8000

10000

12000

14000

T -3 T -2 T -1 T T +1 T +2 T +3

0

200

400

600

800

1000

1200

1400

1600

1800

2000

Capital Inflow Dollar Deposits

Dollarization and Capital flow

Internal Public Debt and Fiscal Deficit

0

10

20

30

40

50

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Source: BSP and BTr

Inte

rnal

Pub

lic D

ebt

-2

-1

0

1

2

3

4

5

Fis

cal D

efic

it

Internal Public Debt Fiscal Deficit

Deficit

Debt

Agency Rating Outlook DateStandard & Poor's BB - stable Jan-05Moody's B1 stable Jan-05Fitch BB stable Oct-03R & I BBB - negative Feb-05

Current Sovereign Ratings of the Philippines

Source: http://asianbondsonline.adb.org

Public Claims in Banks and the Public Deficit -Philippines

0

2

4

6

8

10

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Pub

lic c

laim

s/to

tal c

alim

s

-2

-1

0

1

2

3

4

5

Pub

lic d

efic

it/G

DP

Public claims/total claims Public deficit/GDP

III. Dollarization, sudden stops & economic consequences

3. Dollarization & market bubbles1. Dollarization & short-term capital inflow

2. Stock prices

3. Sudden stops & credit crunch

PHISIX vs FCDU T=1997

0.0

500.0

1,000.0

1,500.0

2,000.0

2,500.0

3,000.0

3,500.0

T-5 T-4 T-3 T-2 T-1 T T+1 T+2 T+3 T+4 T+50.0

2,000.0

4,000.0

6,000.0

8,000.0

10,000.0

12,000.0

14,000.0

16,000.0

Composite Index (end of period)

FCDU

Stock market index

PHISIX vs FCDU T=1984

0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

800.0

900.0

T-3 T-2 T-1 T T+1 T+2 T+3 T+4 T+50.0

500.0

1,000.0

1,500.0

2,000.0

2,500.0

Composite Index (end of period)

FCDU

Real exchange rate vs. FCDU, 1997 Episode

-30.0

-20.0

-10.0

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

T-5 T-4 T-3 T-2 T-1 T T+1 T+2 T+3 T+4 T+5

REER 2000=100 g.r.

FCDU g.r.

Growth of REER vs. FCDU T=1984

-60.0

-40.0

-20.0

0.0

20.0

40.0

60.0

80.0

100.0

T-2 T-1 T T+1 T+2 T+3 T+4 T+5

REER 2000=100 g.r.FCDU g.r.

Latin America

Adopted from “Unlocking Credit”

Philippines, 1984 and 1997

Dollarization in the Philippines:The way in; the way out

Cayetano W. Paderanga Jr.Okinawa, Japan

8 April 2005