Tuesday, 12 April 2011

Want gasoline at P45 a liter?

Business Mirror

You have heard this story before in this column, yet it so perfectly illustrates my point, that I must tell it again. Many years ago an old man (who was the same age then as I am now!) was employed as our gardener. The years and countless bottles of Tanduay had not treated him kindly. One day he asked me why, as a young man, one Philippine peso would buy one US dollar. When he asked the question, the “price” of a dollar was P20.

A proper explanation would have started with the repricing of the British pound to gold after World War I, progressing through the repricing of the dollar to gold and the US government’s confiscation of all privately held gold prior to World War II and, finally, because of the collapse of the 1945 Bretton Woods Agreement in 1971.

Not wanting to spend the item with the true reasons, I simply told him that it was because the US was rich and the Philippines was poorer. That was a false answer then, and it is a false answer now. But the point of my silly story is that my gardener was no less ignorant and uninformed about the reality of foreign exchange than most government policymakers and pundits.

The reason for this discussion about currency is that I am getting annoyed paying P55 per liter for unleaded gas, and there is no reason for that to be happening if the government took proper measures, because it is all about the currency.

A column in another newspaper recently spoke of the price of crude oil. I was a little startled when I read the statement that crude oil had doubled in the last decade, presenting a shocking unawareness about the price of oil. In May 2001 the average price of crude was $27 per barrel. Currently, crude oil is $125 per barrel, making more than a 350-percent increase in the last decade. Since May 2010 oil went up 78 percent in dollar terms from $70 per barrel.

According to this columnist, in principle, oil prices are always determined by supply and demand. By that reasoning, either demand is up 78 percent in one year, or supply is down by that amount, or a combination of both factors. That is not the least bit true.

As the price of any commodity rises, there is an element of speculative pressure that pushes the price higher. This can be the result of nonmarket- related dynamics, such as the political unrest as we have been seeing in the Middle East. However, oil increased 30 percent in the last six months of 2010, long before the protests erupted.

While the government and many “experts” take the view that high oil prices are inevitable and completely outside the control of policymakers, that is not true. By the same token, the assumption is made that Philippine inflation is also inevitable because of rising oil prices. That, too, is false. There are two solutions using sound currency policy.

The Philippine government has over $60 billion in gross international reserves (GRIs). Our import bill in January 2011 for mineral fuels, lubricants and related materials was about $1 billion.

Rather than trying to subsidize fuel costs for politically expedient sectors like jeepney drivers, the government could create a special peso rate for all oil-related imports. Oil-related import costs could easily and quickly be reduced by 20 percent by allowing importers to purchase dollars at a rate 20-percent cheaper than the peso-dollar market exchange rate. A 20-percent currency subsidy for oil imports based on an average annual cost of $15 billion would cost the government about $3 billion for 2011, taken directly from the international reserves, not from the national budget.

Gasoline would immediately drop to around P45 per liter. Most other consumer prices for those goods that a high transportation cost component would also fall. Instead of companies and consumers spending money for imported oil, those funds could be put to building this economy, creating jobs, and increasing the government’s revenue income.

The boldest solution would be to allow the peso to appreciate against the dollar to 40, a 10-percent increase. The simple announcement by the government that it is intended to allow the peso to strengthen to that target would see a dramatic rise in foreign direct investment, foreign purchases of government debt paper and the stock market, and the immediate repatriation of a tremendous amount of money that Filipinos hold offshore. But what about the overseas Filipino workers and exporters? What would happen to them?

Remittances at the most will be $20 billion this year. Total gross exports will be about $50 billion in 2011, and that does not net out the approximately $15 billion of imported components, like electronics that are assembled and then exported. Outsourcing accounts for about $10 billion coming into the country. Each of these sectors wants a depreciated and cheap peso, which is not good for the country. But they also all need to be protected.

It would cost the government less than $10 billion of the GIRs to give these sectors a special peso-dollar rate at a 10-percent discount to market. And also those sectors would be big winners from the increased purchasing power of using pesos domestically.

Either of these two currency policies would significantly reduce the cost of transportation fuel and electric power, as well as the cost of all other imported goods, dramatically increasing the purchasing power of all Filipinos.

It would be as if the nation received a 10-percent wealth increase while, at the same time, reducing prices.

A gradual implementation of these policy options would not disrupt the economy nor create any inflationary pressure from a sudden infusion of money into the system.

The government is not creating sound economic policies. That silly, ill-conceived fuel subsidy is like sticking a pacifier in a crying baby’s mouth until you can prepare the bottle of formula. Eventually, you have to make the baby’s bottle. Pacifiers will not work and is not a long-term healthy option.

When is the Philippines going to have imaginative, innovative and forward-thinking leadership?

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