THE FINANCIAL EXECUTIVE
Business World
I was recently part of a three-man international team tasked by a major donor group to look at the Philippine situation and identify areas where it can direct its assistance. We thought it would be useful to do some scenario analysis of where the country may be five years from now and what are the things that may bring them about.
Scenario 1: Muddling through
Over the past two decades and especially since the Asian crisis, the Philippines' growth pattern can best be described as "muddling through" - not quite able to mount the critical mass of action needed to attract investments and put the country to a higher growth path; not quite performing poorly enough to trigger a crisis, given the reliability of workers remittances and competent fiscal managers who make sure through budget management that the continuing poor revenue performance does not cause a complete loss of creditor confidence, and a fiscal meltdown. This unimpressive and low-quality historic growth record, coupled with the lack of a population management policy, has consigned a third of the people to below the poverty threshold and perhaps their children and grandchildren too, especially if government, due to its budget constraint, continues to falter in providing them the needed education and health care, and the economy the needed physical and institutional infrastructure with which to bring them and the economy out of the poverty cycle.
Without reforms on the fiscal front as well as in the regulatory framework and institutional capability to be able to attract more investments and generate more jobs to keep Filipinos gainfully employed within the country, the Philippines can be expected to continue to just muddle through.
Scenario 2: Crisis.
Worse than muddling through is the risk of an Argentina-like debt crisis founded on government's inability to deal with unsustainable fiscal deficits and growing pubic external debt. The large amount of public debt in foreign currency that needs to be refinanced annually ($4 billion) makes the country vulnerable to event risk, i.e. political or economic event that makes financial markets unwilling to refinance such amounts when due. Political instability feeds this process and vice versa, as seen in many country experiences in the past - including the Philippines in 1983 to 1986. The political situation will have its own dynamics that are completely unpredictable, which may include chaos and installation of a new leader. The impact of such a crisis on the economy could be devastating. During the Philippines' crisis in the mid-'80s, domestic output contracted by 7%-8% for two consecutive years, inflation reached almost 50% in 1984, and the local currency fell from about P8.50/$ to P20.40/$ over a four-year period.
Although this scenario is not very likely under "normal" states of the world, it is an event-triggered nightmare (and there is no telling what external or domestic shock could trigger it), and thus, a very real risk, as can be concluded from an ADB study likening government debt management to a Ponzi game (i.e., incurring new debts to pay for old ones).
Scenario 3: Opportunity
What we labeled a "high" case scenario would see the country achieving the ambitious targets set forth in the Medium Term Philippine Development Plan 2004-2010, that is, by the end of the plan period, a sustainable growth rate of 7.5%, balanced fiscal budget, poverty incidence cut by a third from 30% to 20%. Developments over the past three months have already improved the chances for this outcome: the death of actor-turned political Fernando Poe, Jr. and an effective (if somewhat tragic) end to the presidential electoral challenge; and action taken by the executive that seems to suggest heightened political will to pursue bold action:
Adjustments in power tariffs;
Pushing for new tax measures (indexation of sin taxes which were passed and the increase in the VAT which is in deliberation at the Senate after being passed in the House of Representatives),
Lobbying by the administration that led to the Supreme Court decision favoring the opening up of the mining industry to foreign investors despite opposition from "cause-oriented" groups,
Measures that led to the Paris-based FATF to take the Philippines out of the watch list for money laundering, and
Appointment of highly regarded professionals in key cabinet positions (Departments of Finance, Trade and Industry, Energy and the Bangko Sentral ng Pilipinas) and reportedly providing them with a freer hand than their predecessors.
Early results in terms of positive business confidence, economic growth and job creation will enhance political will, public support, and investor interest and can lead to a virtuous cycle.
Nowhere is this more obvious than in the case of the VAT bill (increasing the rate by 2% and removing most of the exemptions) where we are at the tipping point that will define our long-term direction. This is a crucial piece of legislation that dramatically frontloads government's fiscal efforts in a credible and sustainable way. In the form submitted by the executive, it can yield P52 billion to P75 billion (1% to 1.5% of GDP) per DoF estimates. Given the 1.5% primary surplus (equivalent of private firms' EBITDA) achieved last year, this measure alone could raise the primary surplus to or past the 2.5% of GDP mark computed by the UP economists as the level needed to stabilize the debt to GDP ratio.
Nothing else can yield such an impressive and early result - estimated revenue from sin tax only P15 billion - and no other window exists for such a major fiscal fix given elections coming up in two years. Many investors (both foreign and local) in recent weeks have placed a bet that this bill will pass - thus explaining buoyant activity and pumping up stock market, exchange rate, and credit markets. If the VAT craters, they will surely dump their bets, maybe for the last time.
The country is at a defining moment. Where the VAT goes, the country goes.
