MANILA, Philippines – With the present peso appreciation, most Filipinos may wonder what forces are at play which affect the peso-dollar exchange rates.

The Department of Economic Research of the Bangko Sentral ng Pilipinas explains that like most countries in today’s globalized environment, the Philippines follows a market-determined foreign exchange policy.

This means that the BSP does not fix the exchange rate at a given level, but instead allows the interplay of supply and demand for currency to determine the exchange rate.

The BSP's participation in the foreign exchange market (by either buying or selling dollars) is only to guarantee orderly conditions by preventing wild swings in the exchange rate.

As an illustration, if the supply of US dollars is much more than the demand, the value of the dollar will plunge in peso terms.

This happens, for instance, when overseas Filipino workers send more dollars to their families before Christmas. Such a scenario also occurs when there is a slew of foreign portfolio investments (“hot money”) coming into the Philippines.

These dollars are eventually exchanged for pesos. With more dollars chasing the same amount of pesos, the result is a more expensive peso (If before, a dollar can buy P55, now it can only buy P43).

On the other hand, if many corporations simultaneously buy dollars to pay for their imports, the value of the dollar will tend to rise as against the peso.

It is not the central monetary authority’s role to reverse the underlying trend of the peso, be it appreciating or depreciating. But the BSP does participate in the foreign exchange market to ensure order by mitigating wild swings in the exchange rate.

This is how the BSP “smoothens volatilities.”

If there is a strong supply of dollars relative to the demand in the market, thus causing the peso to appreciate fast, the BSP can soften the appreciation of the peso by buying dollars. (In a reverse situation, where the dollar becomes very scarce, thus causing the peso to depreciate, the BSP sells dollars).

BSP’s action, however, will definitely affect the pesos in circulation. In the first type of operation, the supply of pesos in circulation will increase – an inflationary situation.

Consistent with its mandate to keep the inflation rate low and steady, the BSP will now have to remove from circulation some of the pesos that it has earlier released. This the BSP does by selling government securities or by luring these pesos into special deposit accounts.

All these, of course, the BSP does at a huge cost.

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