Managing for Medium-Term Peso Appreciation 120.0

The usual first response of Filipino exporters and contact and BPO center businesses to a strong peso appreciation is to ask the government, through their industry associations, for a foreign exchange bailout.

With the government considered a soft touch and not proactive, this has created a culture of dependency over the years. It made companies complacent in working on the correct response as the Japanese did after 1971.

Unfortunately, bailouts do not come free and cost money for all Filipino taxpayers as I wrote in the previous post, 119.0.

The last bailout in 2007 lost the Bangko Sentral ng Pilipinas (BSP) PhP102.9 billion of capital reserves as the President through the Monetary Board ordered the BSP to slow down the appreciation of the peso.

I think using the BSP and forex rate management is too blunt an instrument and merely constitutes a windfall transfer payment to favored sectors.

Still, despite the mismanagement of our own economy (in terms of being reactive and of missed opportunities), the U.S. situation is so bad we may experience peso appreciation into the future.

The succeeding administrations’ de facto policy of exporting the poor and unempowered as OFWs has proven a good offset to the loss of industry in money terms (as we do not factor the social costs). The strategy is not robust (marupok); it’s advantage or disadvantage depending on your perspective – it keeps the present politico-economic aristocracy in power.

The current US$ depreciation, to me, represents a long-term trend due to large imbalances in the U.S. economy. We ought to learn from the experience of other countries who have under similar transitions than take the risk of bankrupting our BSP or repeat the experience of boom-and-bust.

The Japanese Experience. In 1971, Japanese companies responded in multiple ways to the expected structural strengthening of the Japanese Yen from the JPY360 to USD1 as the U.S. ended its support to the gold standard. It went up continuously to JPY211 by 1978 (+41.4% in six years).

To keep their profitability, the Japanese companies responded through continuous productivity improvements. They did not by ask for forex rate bailouts (which would not have been granted at that time given unavoidable imbalances beyond the Japanese government’s control). Their choice to take the harder route created a strong foundation for the Japanese economy.

In financial management, Japanese exporters used anticipated exchange rates to make their budgets and price their products accordingly. Thus, they used the anticipated higher exchange rate of JPY308 to budget for 1972.

(Note: Even that 14% appreciation was not sustainable; the Japanese had to float the forex rate for a while, thereafter.)

With a lower divisor, the cost of export products would have risen correspondingly, say by 14%, and make exports uncompetitive. There was a parallel effort to improve productivity through product and process improvements.

Operationally, they implemented various process measures to reduce cost rather than do, what most of our compatriots’ business practice, like managing the cost of inputs, like labor, that depresses the purchasing power of the local market.

As early as the 1960s, the Japanese companies were already into competence building in process management with training programs like Gemba to QC (QC for Foremen).

Companies like Toyota invented lean production management techniques like Just-in-Time (JIT) production and Total Quality Control (TQC). This resulted to continuous productivity improvement and cost reduction and enough preparation for the potential problem that, indeed, happened in 1972.

(Note: JIT and TQC became popular in the west in 1980s when English language books on the subject were published as our reference for these innovations given below.)

Before the advent of design-based competition from the 1990s, these financial and operational innovations and techniques became part of manufacturing tradition and kept the Japanese economy afloat for a few decades from 1972.

Filipino Companies Must Adapt. Filipino companies must likewise adapt business process improvement techniques to survive.

(Note: Some Filipino companies, like the Gokongwei group, have stayed successfully in manufacturing because they have insights from way back – for example, that the true cost of industrial labor is much more than the minimum wage – and factor these into investment decisions. They have similar appreciation of the true cost of capital in the Philippines.)

Most have been so used to managing profits through connections, politics-based protection and input price reduction that they are vulnerable to what I expect is a continuous drop in the US$ value and our government’s future inability – given the weak BSP position – to provide the usual forex rate bailout as cushion.

As I wrote in Post 99.0, other techniques like experimental design to minimize the trial-and-error plagued Filipino SMEs will be helpful.

Finally, new skills like statistical QC that will improve management of variability and change management methods like WorkOut (or older techniques like Quality Circles) can go a long way towards productivity improvement.

Final Notes:

1. OFWs represent a different case from business. I have always advocated policy changes that allow Filipinos to stay and work at home. This includes changes that open up opportunities and increase competition with existing players.

Still, there are ways to insulate OFWs from the expected US$ depreciation. Among these are promoting employment contracts paid in home currencies other than American, i.e. seaman pay in Norwegian Krone, and deployment into other countries.

The best long-term solution is still a strong local economy that employs rather than exports Filipino at livable wages.

2. Richard J. Schonberger’s book published in 1982 is our main reference for the Japanese industrial experiences and innovations above.