Why the BSP restricts foreign funds in SDA investments

SDAs or Special Deposit Accounts are a favorite investment choice of relatively risk-averse people, Filipinos and foreigners alike, looking to park their money in safe, highly-liquid, but high interest-earning instruments.

Such benefits made special deposit accounts very attractive products, which paved the way for more than P1.658 trillion being parked in the central bank’s SDA facility as of June 15, 2012. How big is this amount? Well, this is almost the size of the Philippines’ 2012 budget of P1.816 trillion.

Such humongous amount of peso placements have both advantages and disadvantages.

What are SDAs?

We already wrote about the basics of SDA investing in an article back in 2009. As we have explained before, SDAs are money instruments employed by the BSP as a tool to mop up excess liquidity in the market. Excess funds can lead to inflation and since the BSP’s primary mandate is to control inflation in the country, the agency utilizes several tools to help achieve this goal. Special Deposit Accounts (SDA) are one of these liquidity management tools.

To motivate retail and institutional investors to invest in SDAs, the BSP offers interest rates relatively higher than the rates offered by regular savings and time deposit accounts. Placements are also backed by the BSP, the agency in charge of printing the country’s currency, so there is very low risk of default.

Volatility in foreign exchange

Deposit terms are usually up to one month, meaning, the investor can already earn interest and pull out the placement after one month. This scenario, however, poses a risk to the Philippine’s foreign exchange market because wild swings in the inflows and outflows of currencies can produce volatility in the Peso-Dollar exchange rate.

The Philippine Peso has emerged as Southeast Asia’s fastest-rising currency during the first half of 2012. Partly to blame is the foreigners’ increased appetite for the Peso, dumping the US Dollar (and other foreign currencies) in the process.

Currency carry trade

Worse, some large, foreign institutional fund companies engage in currency carry trade which puts additional pressure to the Peso against the Dollar. Carry trade occurs when fund managers borrow currencies that pay low interest rate (such as the US Dollar or the Japanese Yen) and converts them into currencies paying high interest rates, as in the case of the Philippine Peso and the SDA offering.

Foreign funds flowing into the country contribute to an appreciating peso which may be good to some sectors but it also creates market instability when these funds turn out to be “hot money,” or funds that flow in and out of the country very quickly. Such erratic movement of funds produce, among others, a fluctuating exchange rate.

Resident vs. Non-resident aliens

This erratic currency flow is the reason why the BSP decided to restrict access to SDA placements only to citizens and residents of the Philippines. Non-resident aliens cannot anymore invest in SDAs. The BSP is now requiring banks and financial institutions to issue a notarized certification stating that “none of the funds invested in the SDA have been sourced, directly or indirectly, from non-residents.”

A non-resident alien is defined as a person whose residence is not within the Philippines and who is also not a Filipino citizen.

If this person stays in the Philippines for less than 180 days, he or she is considered a non-resident alien not engaged in trade or business.

If he or she shall stay in the country for an aggregate period of more than 180 days during any calendar year, the person shall be deemed a non-resident alien doing business in the Philippines.

The BSP action to restrict access to SDA investments is a commendable move to protect the Philippine peso from disastrous foreign exchange fluctuations. We have seen how a spike in exchange rates can lead to weak competitiveness among our exporters and lost of currency value for our OFWs. Now that the country is becoming a hot spot for foreign investments, we should definitely welcome foreign funds but, at the same time, we must employ rules and restrictions that will ensure that our country is protected and not taken advantaged of.

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