Foreign exchange policies are designed primarily to achieve both domestic monetary stability and external competitiveness. In an open economy like the Philippines, which is essentially dependent on international trade and capital flows, the foreign exchange rate policies adopted by government have significant effects on the economy. The degree of the country's openness makes it necessary for the country to continually train its exchange rate policies to the requirements of international trade and payments.
Thus, we see the changes that the Philippine peso has undergone through the years out of necessity and by dint of circumstances as the country moves forward in pursuit of economic growth and stability. For almost 20 years after World War II, the Philippine peso was under the fixed exchange rate regime setting a specified par value in terms of the US dollar. Devaluations ostensibly characterized the exchange rate adjustment during this period. With the breakdown of the Bretton Woods agreement in the early 1970s, the peso subsequently joined the band of currencies operating under the floating exchange rate system. During the liberalization years, the peso was on a 'managed float' as monetary authorities frequently stepped in either to prop up the peso or to maintain order in the exchange market. And towards the 1980s, policies have favored the 'freer float' as market forces became significant determinants of the peso's international value.
Fixed Exchange Rate Regime
From the post-war period up to the beginning of the 1960s, the Philippines maintained the official par value of P2.00 to US$1.00. At the outset, the foreign sector started to grow robustly after the reconstruction and rehabilitation efforts of the war-shattered economy. However, in December 1949, the government imposed import and exchange controls to conserve foreign exchange by limiting imports to the amount of foreign exchange receipts available.
Although the official exchange rate was allowed to remain at P2.00 to US$1.00 throughout the 1950s, this rate was considered to be well below what was deemed to be the free market rate at that time. This setting meant an outright subsidy to importers and implicit tax charged on exporters leading eventually to the deterioration of the trade balance. The growth of imports was further abetted by the 1957 presidential elections which prompted an increase in consumer goods imports while exports performed dismally due to unfavorable commodity prices abroad. To avert a balance of payments crisis, a no-dollar import law was passed by the government. This encouraged exports to a certain extent since exporters of specific goods were allowed to use their dollar proceeds to import goods on the basis of an authority from the Central Bank.
The burgeoning trade imbalance as well as the attendant ill effects on the economy would eventually lead to a rethinking of the policy of exchange as well as import controls. The artificially low exchange rate took its toll on the economy in terms of industrial structure and unemployment. Because of the cheapness of the dollar, business prioritized capital-intensive industries to the detriment of the labor-intensive ones. This contributed immensely to the prevailing unemployment problem. The exchange rate policy also proved to be a disincentive to the export sector particularly the sugar bloc which felt shortchanged by the situation. Moreover, the policy paved the way for the emergence of the dollar blackmarket.
In the beginning of the 1960s, adjustment measures such as exchange and import controls proved inadequate in correcting the serios trade imbalances as strong pressures to devalue started to mount from the traditional export sector. Purportedly exporters could get less than what they should from the official market even as changes in domestic prices were far greater than the official exchange rate level could tolerate. While the exchange rate remained constant, inflation ranged from 3-9 percent annually.
In response, the monetary authorities adopted a multi-tier exchange rate system starting April 1960. Under this system, exporters were allowed to surrender 75 percent nof their foreign exchange receipts at the official rate while the remaining 25 percent was valued at the free rate initially set at P3.20 to $1.00. The price of foreign exchange also varied depending on whether the buyer would use the foreign exchange to purchase essential or non-essential imports, the latter being charged the free market conversion rate.
The move launched a gradual decontrol program aimed at ultimately removing the restrictions on exchange transactions in the 1950s and restoring a free foreign trade and payments system. Multiple exchange rates based on an official rate and a free market rate then existed for imports and invisible payments and exports and invisible receipts.
In November 1960, the decontrol program enlarged the amount of transactions valued at the free market rate to 50 percent of all foreign exchange receipts with the exchange rate at the free market reduced to P3.00 to $1.00. At the beginning of the 1960s, the international reserve level stood at $120 million which was barely sufficient to finance three months of merchandise imports.
Still, the peso was deemed to be overvalued even as export receipts failed to keep pace with the demands of importers. Thus, sluggish inflow of foreign exchange coupled with the onerous system of foreign exchange payments prompted monetary authorities to accelerate decontrol. By March 1961, 75 percent of exchange transactions were permitted to be valued at the free market. Although exchange controls were lifted on January 21, 1962 and the peso was freed from the unworkable and widely-evaded mixed-rate system, exporters were permitted to sell only 80 percent of their export proceeds to the Central Bank at the free market rate.
At this time, the foreign exchange market (Foreign Exchange Trading Center), under the auspices of the Bankers Association of the Philippines (BAP), was formally organized.
The decontrol, however, was not complete as the remaining 20 percent of export receipts was required to be sold at the controlled rate. On November 8, 1965, the decontrol program was completed and the peso was devalued to P3.90 to a dollar. At end-1965 the international reserve level rose by 53 percent as the devaluation stimulated the traditional exports. The devaluation, however, had deleterious effects on the import-dependent manufacturing sector. The beneficial effects of the devaluation proved transitory. Imports, which grew minimally in 1965, went up by 6 percent in 1966 and 25 percent in 1967 while exports, which registered an eight percent increase in 1966, decreased in 1967 and grew by only 5 percent in 1968.
In hindsight, it can be said that the experience of the country under the fixed exchange rate system was characterized by mounting extenal imbalances followed initially by an increasing reliance on trade and exchange controls and finally by a sudden and large devaluation when the prevailing exchange rate could no longer be defended. The fixed rate system proved to be an inadequate framework of adjustment. More than enough reserves were needed to keep up with the requirements of foreign trade when devaluation was not feasible. Unfortunately, the country had very little foreign exchange coming from exports and devaluation became necessary.
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