The economy: What happens this year? – Part II Domestic Philippine economic environment

Here are some aspects to consider in understanding what happens to the Philippine economy this year.

The first is to analyze how sound are the “macroeconomic fundamentals.” This means keeping the fiscal, monetary and the investment fronts vibrant but stable. They should facilitate an economy that is operating without crises or imbalances.

The second is to examine how the economy is performing in accordance with existing policies. This includes understanding where productivity improvement is happening.

The third concerns probing into the reforms that are being undertaken to close gaps in economic policies.

Economic fundamentals. The national economy remains on a fundamentally positive track. The country has been on a good economic growth track, but at a low level compared to neighbors. In previous discussion in this column, I have noted how we have lagged behind impressive East Asian neighbors.

The economy this year is projected to grow around at the rate of 6.5 percent. But year after year in recent years, the growth of the economy has been marked by the relative expansion of services with a relative decline of industrial and even agricultural output to total output.

The economic fundamentals in recent years have improved. A healthy balance of payments picture supports this outlook. This results from the resurgence of export performance and rising overseas Filipino worker (OFW) remittances.

The dominance of income flows from OFW remittances to Philippine households has made consumption rather than investment the driver of the economy’s growth process. In one sense, this is a bad omen because there is underinvestment in major facilities in the country.

The economy’s productive capacity may not grow in the desired direction. This growth might bring about the expansion of basic consumption needs. It could encourage an alternative outcome. The domestic income chain might favor imports of consumer goods when domestic industries are not competitive.

Lack of investment in domestic infrastructure and the low investments in agriculture and industry characterize recent trends. Foreign direct investment has less presence in the Philippines compared to other high growth neighbors.

Fiscal front. The government’s fiscal position suffers from weakness. Tax performance is low and needs improvement. Despite recent efforts to improve excise taxation, the nation is handicapped in financing high priority public expenditure. If the threat of a Congressional faction to cut the 12-percent value added tax (VAT) rate by 50 percent materializes, this performance could even fall disastrously lower.

To control the fiscal position, the government seeks to bring the fiscal deficit at the level of three percent of gross domestic product (GDP). Administrative measures to improve tax collections are part of the government’s plan to deal with the fiscal issue.

New government budgetary spending on the social sectors – education, health and the very poor  – will have increased allocation. A lesson learned from the past is that governments often spend what they plan but their estimates of revenues to cover these expenses fall short. Hence deficits widen.

The Aquino presidency will therefore be tested in its first full fiscal year. Unless discipline is kept on the spending front, restrained fiscal deficit target is likely to be breached.

Monetary front. The central bank’s monetary stance is alert to the inflationary expectations arising from the fiscal problem and aggregate demand. Interest rates have been low in part because the domestic economy is flush with liquidity. The positive balance of payments position creates for this monetary phenomenon.

The monetary stance during the year is also delicately related with the exchange rate of the peso. Will the peso strengthen? Fundamentally the policy needs to balance the economy’s anti-inflationary policy with the use of the exchange rate to maintain international competitiveness of domestic industries. Continued appreciation in the past has penalized exports while it kept inflation under control.

So far the central bank has been able to stabilize monetary policy by demonetizing excess liquidity through the special deposit accounts of the banking system, by allowing treasury floats of bonds against dollar liquidity, and through the appreciation (or strengthening) of the peso.

Domestic investment demand. The Aquino government hopes to raise domestic investment by building up of domestic infrastructure projects through the encouragement of public-private partnerships (PPPs). This is easier said than done. The list of PPP projects is long but implementation is possible only if the investment feasibility studies are ready.

The mechanism for PPPs depends heavily on the contractual instrument. In general, they will include foreign investment partners but they are led by domestic partners. Variations of build-operate-transfer (BOT) arrangements will likely dominate the investment instruments. This is why the term PPP is simply new clothing for something very old.

We have had experience with BOT arrangements especially during the great effort to conquer the electricity crisis of the 1990s. We know the high cost of the results to the economy when undertaken under emergency conditions.

The BOTs would require heavy participation of domestic capital which however is very limited. The deficiencies in capital, expertise, and technological capability of local partners necessitates that PPPs include the participation of foreign direct investments.

But current policies hamper the attainment of appropriate mix of PPP participation of foreign capital. The economic regulations are traceable to the economic restrictions that are part of the constitutional provisions. BOT contracts that result will be biased in giving greater weight to domestic equity contributions when the main source of finance might originate from the foreign capital side. The resulting contract could generate high rents for domestic partners that are not commensurate to the capital that they will bring to the project. Hence project costs will likely be more expensive.

Unless attention is given to constitutional reforms of the restrictions to foreign direct investments, many BOT arrangements will involve high rents for relative bystanders in the process of providing the investment effort.

Key thrusts of the government: business as usual on many fronts. With six months gone by and the development plan about to be launched, it is possible to see the key thrusts of the government in 2011. The development plan of the government is still under consideration. But recent announcements from the presidential office provide indications of the key economic thrusts during the year. The priority legislation submitted to Congress do not include milestones in reforming economic policy with regard toward improving the investment climate.

The theme of the thrusts of the government is essentially business as usual. Thus, the message is eliminate corruption. Reduce red tape. Intensify administrative improvements. Promote more investments.

The only genuine new reform initiative that the Aquino government appears to make is to support a reproductive health bill. This will make a major impact on the future population profile over time. The resolve to make this bill contribute to the population issue received the most unexpected support from the Pope himself.

When the Pope accepted the use of the condom as a weapon against the spread of a serious public health issue (the HIV/AIDS epidemic), he opened up the possibility that a vigorous resolution of the debate on family planning in the country would result in a new law on reproductive health.

Whatever might be the outcome of the bill in this year’s Congress on the country’s future population, there are already many young people who are already here with us who will need to be fed or to be employed. –Gerardo P. Sicat (The Philippine Star)