Fig. 1 shows the exchange-rate market for Philippine pesos, measured as US dollars per PHP. In 2025, a Filipino electronics exporter received more foreign o...
Question 1 Report
Fig. 1 shows the exchange-rate market for Philippine pesos, measured as US dollars per PHP. In 2025, a Filipino electronics exporter received more foreign orders after the peso depreciated. The equilibrium moved from E1 to E2 following a fall in foreign demand for Philippine financial assets. The exporter expects its dollar price to become more competitive, while it also imports computer chips priced in US dollars. The central bank is deciding whether to use foreign currency reserves to support the peso. Its decision could influence inflation, the price of imports and the balance of trade.
(a) Identify the change in demand for pesos shown in Fig. 1 and state what happens to the exchange rate. [4]
(b) Calculate the percentage depreciation of the peso between E1 and E2. Show your working. [6]
(c) Explain how this depreciation could affect the exporter’s sales revenue, its imported chip costs and the country’s trade balance. [8]
(d) Explain whether the central bank should sell foreign currency reserves to prevent the depreciation. [12]
Answer Details
(a) Demand for pesos shifts left from D1 to D2. [1] This is caused by lower foreign demand for Philippine financial assets and hence pesos. [1] The exchange rate falls from US$0.018 to US$0.015 per PHP. [1] The peso therefore depreciates. [1]
(b)
\[0.018-0.015=0.003\]
\[\frac{0.003}{0.018}\times100=16.7\%\]
The peso depreciates by 16.7%, accepting 17%. [6]
(c) Philippine exports become cheaper in US-dollar terms. [1] Foreign demand for electronics may therefore rise. [1] The exporter also receives more pesos for each dollar of export revenue. [1] However, imported computer chips become more expensive in pesos. [1] This raises production costs, so the firm may raise prices or receive lower profit. [2] Import quantity may fall, but import spending can rise if demand is price inelastic. [1] The trade balance improves only if export and import demand are sufficiently price elastic and contracts have time to adjust. [1]
(d) Selling foreign-currency reserves buys pesos and increases demand for the peso. [1] It can limit imported inflation, protect real incomes, reduce uncertainty for firms with foreign debts or import contracts, maintain investor confidence and prevent an exchange-rate overshoot. [5] However, reserves are finite, intervention may only delay a market-driven depreciation, and a weaker peso improves export competitiveness, tourism receipts and remittances in peso terms. [4] Supporting the peso may keep imports artificially cheap and worsen the current account; interest-rate or fiscal reforms may address the underlying loss of confidence more effectively. [2]
Judgement: Limited temporary intervention can be justified during disorderly trading, but sustained defence is unlikely to be appropriate unless policy also tackles the cause of weaker foreign demand. [1]
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