THE FINANCIAL EXECUTIVE
Business World
Nobel prize winner Robert Mundell will be flying into Manila this week courtesy of the Bridges Program of the International Peace Foundation to give a talk on "economic development by fitting globalization into the national development strategy." While the topic is certainly stimulating, I would guess many will be going there, myself included, to hear what he had to say about the country's current policy dilemma, which is all about dealing with sharp peso appreciation due to exceptionally strong dollar inflows.
If one were to think of economists whose ideas have been most relevant for emerging market economies such as the Philippines, Dr. Mundell would certainly be very high up that list.
Repeatedly, local central bankers are learning that, no matter the effort, one cannot completely defy the results of the Mundell-Fleming model (also independently studied by Marcus Fleming). The impossible trinity, an important offshoot of that analysis, states that for as long as financial capital can freely flow in and out of a country, one cannot hope to simultaneously control that country's exchange rate and money supply.
With strong inflows into the economy, particularly in the form of overseas Filipino workers' (OFWs) remittances and foreign investments, the Bangko Sentral ng Pilipinas (BSP) has been grappling with the problem of how to keep the peso from excessively strengthening.
There is understandably strong pressure to curb peso appreciation, given the impact on dollar earners such as OFWs and small- and medium-sized exporters. Even giant telecoms companies like Globe and PLDT have begun to feel the effect of a cheap dollar, noting how rapid appreciation has substantially trimmed their profits (from international operations).
Dollar-buying by the BSP to build foreign exchange reserves increases the demand for dollars in the spot market and helps to weaken the peso. However, the increase in net foreign assets leads to an increase in money supply, which is a no-no for an inflation targeter hoping to keep a lid on prices. Mopping up excess liquidity in the financial system, however, eventually requires tighter monetary policy and higher interest rates, which in turn leads to further peso appreciation, as the "impossible trinity" would dictate.
In order to tame upside pressures on the peso, the central bank has also been using its surplus dollars to prepay foreign debt and has changed its financing mix toward domestic financing, urging the national government to do the same. While turning to the domestic market for funding means lesser inflow of dollars, it also implies competition for local funds and an increase in local borrowing rates. Again, the uptick in interest rates would mean more attractive domestic assets and a possibly stronger peso.
Monetary authorities have tried to bypass the policy dilemma through foreign currency swaps, wherein dollars are siphoned from the spot market and immediately swapped with pesos in order to prevent an increase in domestic liquidity.
The arrangements with counterparty banks are flexible enough and can be renegotiated as needed, but still such measures have not been without cost. Recently, such transactions have turned up forex fluctuation losses (amounting to P50 billion) in the central bank's net income statements, putting the institution in the red.
Thursday will be another day of reckoning for BSP, and monetary authorities will again have to heed what Mundell said a long time ago - that is, trying to keep the value of the domestic currency stable against an anchor currency means following that foreign government's policy rates anywhere it goes.
With the Fed having cut its rates last week, the BSP will have little choice but to cut its own rates during the scheduled rate-setting meeting, if it hopes to rein in further peso appreciation.
With workers' remittances remaining strong, it has been said that cutting rates may not stop dollar inflows since OFWs are largely insensitive to interest differentials (i.e., used for household and schooling expenses). However, for foreign investors, a higher effective return will surely make peso assets even more attractive, especially for those who were already interested in investing in the country in the first place.
Fortunately, the conditions for the BSP cutting rates are benign enough. From a strict inflation targeting perspective, current inflation, at 2.7%, remains way below the 4%-5% inflation target range (thanks largely to peso appreciation).
Domestic liquidity growth has slowed and while oil prices are rapidly rising, inflation expectations remain low, with the average forecast of private economist ranging from 2%-3% this year and 3%-4% the next.
John Maynard Keynes once said that we are, without knowing it, slaves to some dead economist. Mundell is alive and well and so are his ideas, and as we are painfully learning, neither can we escape the implications of his theories.
* * *
Mundell's talk will be held on November 15 at 2 p.m. at the De La Salle University in Manila (in cooperation with the Mapua Institute of Technology). For further information, you can e-mail eclee@dlsu.edu.ph, yuhicoa@dlsu.edu.ph or call (02) 525-6950.
Tuesday, November 13, 2007
Tuesday, August 28, 2007
Holding steady in rough water
THE FINANCIAL EXECUTIVE
Business World
This article was written before the stock market's recovery on August 21, 2007. Investors, however, can expect recurring concerns about the impact of current problems in the US credit market on its economic growth and on growth in the rest of the world. Whether it was a general flight from risky assets or the unwinding of hedge funds' exposures to fund redemptions by investors alarmed by the so-called unknown unknowns, the exit of "hot money" in weeks past has pulled Philippine equity prices back to late 2006 levels.
Since the week of July 23, the composite stock price index has lost 23% while the peso has reversed course, losing nearly 4% against the dollar even as monetary authorities tempered its fall.
Local investors, who may be bracing for continued volatility as the US subprime drama plays out, have started to shift to the safety of bonds. As a result, spreads on Philippine sovereign bonds, which have been hammered by fiscal slippages reported a month ago, have narrowed in recent weeks.
Current market conditions suggest that pipeline equity initial public offerings (IPOs) are likely to be pushed out.
Nevertheless, unlike in 1997 when the financial crisis that swept across Asia quickly escalated into an economic crisis, the domestic economy this time around is in much better shape to weather the turbulence, as long as the US economy itself avoids a hard landing. Improved macroeconomic stability in recent periods, accompanied by more resilient financial institutions, has weakened the transmission channels from financial to economic crises as discussed below.
1. Re-pricing of risk and increased hurdle rates. The global flight to quality and drying up of liquidity has raised renewed concerns about government's fiscal consolidation program with fears of rising funding costs. As the narrowing of spreads in past weeks indicates, however, this risk is small as local investors, who look at government securities as safe havens, are major buyers of government bonds. At the same time, the increased depth of a still very liquid domestic market (resulting in a flatter yield curve in peso issues), coupled with the peso's recent strength, has allowed government to move away from dollar financing, borrowing in pesos to retire foreign debt.
Other factors that should provide more comfort include: (a) the decline in government's debt ratio following reduced budget deficits, healthy primary surpluses, and the economy's growth, (b) a robust dollar war chest consisting of $26 billion in gross international reserves, some $10 billion in forward dollar purchases and $18 billion in FCDU deposits, which together is enough to cover the country's $54 billion stock of foreign debt, and (c) positive current account position with no letup in remittance inflows.
2. Bank lending. The beating that bank stocks took lately may reflect investors' fears that local banks, following government's improved finances and themselves flushed with liquidity and risk appetite whetted, had invested in these securities to realize higher yields. Already, the Bangko Sentral ng Pilipinas has stated that local banks have minimal exposures (reportedly 0.2% of total assets) to collateralized debt obligations (CDOs) and that these holdings consist of higher quality tranches, not the subprimes. This is comforting news because even if the crisis spread to the higher-rated tranches (as it already has), the odds that, as a group, banks' balance sheets will be impaired will be small (especially since banks' investments in such instruments are limited by prudential rules to the size of their dollar books). Moreover, Philippine banks today are in better health, having disposed of a large part of their bad assets in recent years and mergers having led to bigger, stronger, and better capitalized banks. Bank lending has in fact started to rise in real terms - a course unlikely to be affected by any CDO holdings.
3. Corporate sector weakness. While some of the bigger firms, which had taken advantage of favorable market conditions to raise financing and have been cash-rich while waiting for investment opportunities in the domestic economy, may have parked funds in the meantime in CDOs, it is not very likely that they will be holding much of these securities, either. They would most likely have diversified their investments and even if they had initially raised financing in dollars, they would have converted to pesos by now in light of the dollar's weakness.
4. Outflow of portfolio investments. This has contributed to financial market volatility but is not likely to have any real sector impact. The peso's depreciation following its rapid appreciation in recent periods should in fact be a welcome development for monetary authorities striving to balance multiple objectives as well as for dollar earners such as exporters and overseas Filipino workers (OFW).
Be that as it may, the peso is not likely to fall back to the mid-50s level of two years ago. Unlike in 1997, the peso's strength today is fundamentally supported by surpluses in the current account, which has benefited from the regular inflow of remittances from OFWs. These remittances reached nearly $13 billion last year and grew a further 18% in 1H07. Together with the country's international reserve level, which at the end of July is equivalent to three times debts maturing in the next 12 months, these provide sufficient cushion against temporary outflows of portfolio investments.
The remaining wild card, from the domestic economy's point of view, is the risk of a hard landing in the US. While some analysts have been alerting markets to this rising risk, reading into the US Fed's liquidity infusion and 50bp discount rate cut as a shift in concern from inflation to growth, many believe that the risk is still small at the moment.
I think that the Philippine economy is resilient enough to weather a US growth slowdown. The emergence of China and increased integration of Asian economies have allowed the Philippine economy to "de-couple" to some degree from the US economy. For instance, total Philippine trade with the US has slipped from approximately 25% of overall trade in 2000 to 17% last year.
As well, the stock market's swift recovery sends a positive signal of investors' continued confidence in the economy's prospects.
Romeo L. Bernardo is president of Lazaro Bernardo Tiu and Associates (LBT), a boutique financial advisory firm based in Manila and serves as GlobalSource economist in the Philippines
Business World
This article was written before the stock market's recovery on August 21, 2007. Investors, however, can expect recurring concerns about the impact of current problems in the US credit market on its economic growth and on growth in the rest of the world. Whether it was a general flight from risky assets or the unwinding of hedge funds' exposures to fund redemptions by investors alarmed by the so-called unknown unknowns, the exit of "hot money" in weeks past has pulled Philippine equity prices back to late 2006 levels.
Since the week of July 23, the composite stock price index has lost 23% while the peso has reversed course, losing nearly 4% against the dollar even as monetary authorities tempered its fall.
Local investors, who may be bracing for continued volatility as the US subprime drama plays out, have started to shift to the safety of bonds. As a result, spreads on Philippine sovereign bonds, which have been hammered by fiscal slippages reported a month ago, have narrowed in recent weeks.
Current market conditions suggest that pipeline equity initial public offerings (IPOs) are likely to be pushed out.
Nevertheless, unlike in 1997 when the financial crisis that swept across Asia quickly escalated into an economic crisis, the domestic economy this time around is in much better shape to weather the turbulence, as long as the US economy itself avoids a hard landing. Improved macroeconomic stability in recent periods, accompanied by more resilient financial institutions, has weakened the transmission channels from financial to economic crises as discussed below.
1. Re-pricing of risk and increased hurdle rates. The global flight to quality and drying up of liquidity has raised renewed concerns about government's fiscal consolidation program with fears of rising funding costs. As the narrowing of spreads in past weeks indicates, however, this risk is small as local investors, who look at government securities as safe havens, are major buyers of government bonds. At the same time, the increased depth of a still very liquid domestic market (resulting in a flatter yield curve in peso issues), coupled with the peso's recent strength, has allowed government to move away from dollar financing, borrowing in pesos to retire foreign debt.
Other factors that should provide more comfort include: (a) the decline in government's debt ratio following reduced budget deficits, healthy primary surpluses, and the economy's growth, (b) a robust dollar war chest consisting of $26 billion in gross international reserves, some $10 billion in forward dollar purchases and $18 billion in FCDU deposits, which together is enough to cover the country's $54 billion stock of foreign debt, and (c) positive current account position with no letup in remittance inflows.
2. Bank lending. The beating that bank stocks took lately may reflect investors' fears that local banks, following government's improved finances and themselves flushed with liquidity and risk appetite whetted, had invested in these securities to realize higher yields. Already, the Bangko Sentral ng Pilipinas has stated that local banks have minimal exposures (reportedly 0.2% of total assets) to collateralized debt obligations (CDOs) and that these holdings consist of higher quality tranches, not the subprimes. This is comforting news because even if the crisis spread to the higher-rated tranches (as it already has), the odds that, as a group, banks' balance sheets will be impaired will be small (especially since banks' investments in such instruments are limited by prudential rules to the size of their dollar books). Moreover, Philippine banks today are in better health, having disposed of a large part of their bad assets in recent years and mergers having led to bigger, stronger, and better capitalized banks. Bank lending has in fact started to rise in real terms - a course unlikely to be affected by any CDO holdings.
3. Corporate sector weakness. While some of the bigger firms, which had taken advantage of favorable market conditions to raise financing and have been cash-rich while waiting for investment opportunities in the domestic economy, may have parked funds in the meantime in CDOs, it is not very likely that they will be holding much of these securities, either. They would most likely have diversified their investments and even if they had initially raised financing in dollars, they would have converted to pesos by now in light of the dollar's weakness.
4. Outflow of portfolio investments. This has contributed to financial market volatility but is not likely to have any real sector impact. The peso's depreciation following its rapid appreciation in recent periods should in fact be a welcome development for monetary authorities striving to balance multiple objectives as well as for dollar earners such as exporters and overseas Filipino workers (OFW).
Be that as it may, the peso is not likely to fall back to the mid-50s level of two years ago. Unlike in 1997, the peso's strength today is fundamentally supported by surpluses in the current account, which has benefited from the regular inflow of remittances from OFWs. These remittances reached nearly $13 billion last year and grew a further 18% in 1H07. Together with the country's international reserve level, which at the end of July is equivalent to three times debts maturing in the next 12 months, these provide sufficient cushion against temporary outflows of portfolio investments.
The remaining wild card, from the domestic economy's point of view, is the risk of a hard landing in the US. While some analysts have been alerting markets to this rising risk, reading into the US Fed's liquidity infusion and 50bp discount rate cut as a shift in concern from inflation to growth, many believe that the risk is still small at the moment.
I think that the Philippine economy is resilient enough to weather a US growth slowdown. The emergence of China and increased integration of Asian economies have allowed the Philippine economy to "de-couple" to some degree from the US economy. For instance, total Philippine trade with the US has slipped from approximately 25% of overall trade in 2000 to 17% last year.
As well, the stock market's swift recovery sends a positive signal of investors' continued confidence in the economy's prospects.
Romeo L. Bernardo is president of Lazaro Bernardo Tiu and Associates (LBT), a boutique financial advisory firm based in Manila and serves as GlobalSource economist in the Philippines
Tuesday, July 10, 2007
The Philippines: Back in business?
THE FINANCIAL EXECUTIVE
Business World
A few weeks ago, Ambassador Bobby Romulo invited me to present an overview of the Philippine economy to a small group of business leaders. From the flow of discussions that followed, there seemed cautious optimism all around.
Let me share a few highlights of my presentation:
I. IS IT TIME TO LOOK AT THE PHILIPPINES?
The Philippines was reported to have grown by 6.9% last quarter on the back of a 5.4% growth in 2006 (GNP at 6.2%), the first time that the country recorded three consecutive years of over 5% growth since the 1970s. This robust and resilient growth was achieved on the back of a major fiscal adjustment and relative political and governance "unease." (This prompts the question of how well the country could be doing if these were absent!) Hurdle rates to investments are also lowest in years, driven by fundamental improvement in macro risk profile and an increase in global liquidity looking for investments in emerging markets.
Macroeconomic risks have been significantly reduced: The country has a record surplus in the consolidated public sector balance in 2006 (from a deficit of around 5% of GDP in 2004); sustained low inflation and interest rates; a strong current account position (4% of GDP in 2006); record BSP reserves, covering over 2-1/2 times short-term maturing debt; and much reduced financial sector risk as banking system has become healthier now than it has ever been in a decade.
Relative political calm can be expected. The President has weathered the political crisis that reached its height with the resignation of 10 of her key cabinet secretaries in July 2005. The midterm elections were relatively orderly and calm. And while the election results were mixed - the administration overwhelmingly won the local government and House of Representative posts, and the opposition, the Senate - there is no reason to believe that there can be any chance of successful challenges to the President through extraconstitutional means (people power, coups, etc.) or revival of an impeachment case against her.
While there may be a wild card in terms of how the case against former President Estrada will play out, the expectation is that all eyes are now on the 2010 elections and for a peaceful turnover to a new administration which will preserve this administration's good legacies, e.g., in the fiscal front.
II. DRIVERS TO GROWTH: ROBUST AND SUSTAINABLE?
Recent performance has been driven on the demand side by double-digit growths (20% and 15%, respectively) in remittances (fueling consumption growth, balance of payments stability, and unemployment and social/political safety nets) and exports. On the supply side, growth was led primarily by the services sector.
My own assessment is that remittances will continue to grow, perhaps not as robustly as in the past couple of years but will endure for sometime still, constrained perhaps over the very long term only by the inability of the educational system to produce skilled workers - a problem that has been recognized and will hopefully be addressed.
The electronics sector's resiliency may be due to the way production in the region has become network based (i.e., Philippine exports/imports consist mainly of parts and components e.g., 56% of total exports in 2003 vs. 20% in 1990), with comparative advantage built over time for being "first mover" in particular niches. The recent large ($1.8 billion) investment of Texas Instruments, bagged by public-private collaboration led by Trade and Industry Secretary Peter Favila, well illustrates this continuing competitiveness (which government needs to work on to sustain).
The Philippines is very competitive in BPO services, ranking second in an IMF list of countries based on an aggregate assessment of such factors as people, service maturity, financial benefit, and infrastructure. The sector is forecast to continue expanding quite rapidly through 2010.
III. RESIDUAL RISKS?
Fiscal Reform Sustainability. The expanded VAT, fully supported by both branches of government, as well as business, academe, and responsible civil society, together with correct pricing of power and some expenditure compression, improved the fiscal picture immensely over the last two years. This year, however, there were some slippages in collection, leading to the replacement of the BIR chief. I believe this demonstrates the resolve of the current administration to preserve its fiscal legacy. With the current financial/economic team, it is highly unlikely this will be compromised.
With no new taxes contemplated, the Department of Finance is focused on improving the administrative efficiency of tax collection. Continuing efforts on this is critical for the following reasons: the tax-to-GDP ratio, at 14%, is still low; debt-to-GDP ratio is still high; and the country has been under-investing, not just in physical infrastructure but also in social capital, especially education.
Power. The only thing to flag is the obvious one: if the Philippines aspires to grow at high levels, new power plants will have to be built pretty soon. The critical period by Department of Energy estimates is 2010, and there seems to be an indication that at least small ("peaking") plants are already being built to respond to this need.
Inflation/Asset Bubble? Is an asset bubble building on the back of high liquidity growth (26% in April)?
Not at this point. Office rents in Makati and stock prices are still roughly 40-50% below where they were in 1997, when corrected for inflation. Moreover, banks continue to be cautious in lending, and price multiples are nowhere near those observed in other regional equities markets, especially China. More fundamentally, in contrast to 1997, asset price increases are being driven by real economic activity rather than hot money.
Globally, while risks continue to arise from crash landings in the US housing sector, disorderly unwinding of global imbalances, and bursting of bubbles elsewhere in the world (notably, China), most of these have receded somewhat from conditions in September last year as noted in the latest IMF World Economic Outlook.
IV. WHAT IS THE OUTLOOK?
Private GDP forecasts range from 5.3% to 6.4% in 2007 and from 5.4% to 6.4% in 2008. It should be clear though that most analysts appreciate that the Philippines has momentum. Whether this translates to improved long-term performance depends on whether the opportunities created by this momentum, improved fiscal space, and favorable external environment are used by government to bring the economy to the next level through strong reforms, sound policies, and truly wise development spending. In short, the "legacy thing."
Tuesday, June 26, 2007
The impossible trinity
MAP INSIGHTS
Business World
Over the past several months, the market has been following closely the policy pronouncements of the Bangko Sentral ng Pilipinas (BSP), in search of clues to where monetary and exchange rate policy is heading. The BSP has been forthright in expressing its concern over recent surges in capital flows that led to the strengthening of the peso (over 12% appreciation from end-May 2006 to end-May 2007) and the high growth in money supply (26% M3 growth as of April 2007).
Complicating matters, however, is that on top of inflation and the country's export competitiveness, the BSP is also worried about the continued weakness in lending activity, despite massive liquidity in the banking system.
Given multiple policy objectives, the BSP has been putting forward more and more innovative policy tools. For instance, to encourage bank lending, it introduced a tiering scheme on its policy rates in November 2006 such that higher levels of deposits with the BSP earn less interest. On the other hand, rather than removing interest rate tiering in the face of continued high growth in domestic liquidity, it opted, in early May this year, to expand its open market operations to trust entities, allowing these to deposit funds with the BSP using the same interest tiering structure. Most recently, the papers reported that it is toying with the idea of introducing a gold-backed investment instrument, using some of the foreign exchange inflows to import gold.
The BSP's policy dilemma reminds me of an article by the economist Paul Krugman that I read a long time ago. As I recall, he explained the problem using a triangle where each vertex represents policy objectives that are desirable, i.e, monetary policy independence, currency stability, and capital mobility. Each side of the triangle, corresponding to a specific policy regime, is however consistent with only two of the objectives, such that a country's economic managers would have no choice but to give up on one of the objectives.
To illustrate, the side linking policy independence and currency stability (i.e., a fixed exchange rate regime) is not consistent with capital mobility. As the 1997 Asian crisis showed, by practically fixing the exchange rate while allowing free flow of capital, the Philippines and the other crisis-hit countries became vulnerable to severe speculative attacks as soon as markets suspected that the policy regime was not sustainable without an adjustment in the exchange rate.
The side linking currency stability and capital mobility may characterize a Hong Kong-like currency board regime, or a currency union similar to that in Europe, or a return to the gold standard. Countries adopting these policy regimes do not have the flexibility to use monetary policy for stimulating or reining in growth and thus are susceptible to volatile swings in their business cycles.
Finally, the side linking policy independence and capital mobility represents a floating exchange rate regime, which is what the BSP has gradually warmed up to after the Asian crisis. As its recent actions showed, it has been using monetary policy to influence lending activity and thus economic growth. It has repeatedly shunned capital controls similar to what Malaysia did during the Asian crisis and what Thailand recently tried to do, albeit less successfully. In return, it has opted to accept the reality of a more volatile currency.
I think our financial and monetary authorities are doing a deft act of juggling, using various tools, to try to meet these three objectives (four if one factors in its own balance sheet concerns, which textbooks tell us should not be a primary consideration for a central bank) in the face of new unexpected inflows, especially "hot money." They intervene surgically to even out sharp peso appreciations, retire foreign debt with domestic debt to create demand for dollars, and ease up on outward remittance restrictions.
The good thing is that a large part of today's capital flows come from OFW remittances. Unlike hot money, these are not volatile and indeed are likely to be sustainable, considering that (a) "event risk" is minimized given the diversity in terms of type of workers and geographical distribution; (b) higher wages abroad will continue to attract Filipinos to work overseas; and (c) the aging population of industrialized countries provides the potential for a relatively younger Philippine population to fill labor gaps. Thus, we see the BSP allowing peso appreciation to reflect this reality.
The article reflects the personal opinion of the author and does not reflect the official stand of the Management Association of the Philippines. The author is director of Lazaro Bernardo Tiu & Associates and Advisor of Global Source, an international network of independent analysts (www.globalsourcepartners.com).
The impossible trinity
MAP INSIGHTS
Business World
Over the past several months, the market has been following closely the policy pronouncements of the Bangko Sentral ng Pilipinas (BSP), in search of clues to where monetary and exchange rate policy is heading. The BSP has been forthright in expressing its concern over recent surges in capital flows that led to the strengthening of the peso (over 12% appreciation from end-May 2006 to end-May 2007) and the high growth in money supply (26% M3 growth as of April 2007).
Complicating matters, however, is that on top of inflation and the country's export competitiveness, the BSP is also worried about the continued weakness in lending activity, despite massive liquidity in the banking system.
Given multiple policy objectives, the BSP has been putting forward more and more innovative policy tools. For instance, to encourage bank lending, it introduced a tiering scheme on its policy rates in November 2006 such that higher levels of deposits with the BSP earn less interest. On the other hand, rather than removing interest rate tiering in the face of continued high growth in domestic liquidity, it opted, in early May this year, to expand its open market operations to trust entities, allowing these to deposit funds with the BSP using the same interest tiering structure. Most recently, the papers reported that it is toying with the idea of introducing a gold-backed investment instrument, using some of the foreign exchange inflows to import gold.
The BSP's policy dilemma reminds me of an article by the economist Paul Krugman that I read a long time ago. As I recall, he explained the problem using a triangle where each vertex represents policy objectives that are desirable, i.e, monetary policy independence, currency stability, and capital mobility. Each side of the triangle, corresponding to a specific policy regime, is however consistent with only two of the objectives, such that a country's economic managers would have no choice but to give up on one of the objectives.
To illustrate, the side linking policy independence and currency stability (i.e., a fixed exchange rate regime) is not consistent with capital mobility. As the 1997 Asian crisis showed, by practically fixing the exchange rate while allowing free flow of capital, the Philippines and the other crisis-hit countries became vulnerable to severe speculative attacks as soon as markets suspected that the policy regime was not sustainable without an adjustment in the exchange rate.
The side linking currency stability and capital mobility may characterize a Hong Kong-like currency board regime, or a currency union similar to that in Europe, or a return to the gold standard. Countries adopting these policy regimes do not have the flexibility to use monetary policy for stimulating or reining in growth and thus are susceptible to volatile swings in their business cycles.
Finally, the side linking policy independence and capital mobility represents a floating exchange rate regime, which is what the BSP has gradually warmed up to after the Asian crisis. As its recent actions showed, it has been using monetary policy to influence lending activity and thus economic growth. It has repeatedly shunned capital controls similar to what Malaysia did during the Asian crisis and what Thailand recently tried to do, albeit less successfully. In return, it has opted to accept the reality of a more volatile currency.
I think our financial and monetary authorities are doing a deft act of juggling, using various tools, to try to meet these three objectives (four if one factors in its own balance sheet concerns, which textbooks tell us should not be a primary consideration for a central bank) in the face of new unexpected inflows, especially "hot money." They intervene surgically to even out sharp peso appreciations, retire foreign debt with domestic debt to create demand for dollars, and ease up on outward remittance restrictions.
The good thing is that a large part of today's capital flows come from OFW remittances. Unlike hot money, these are not volatile and indeed are likely to be sustainable, considering that (a) "event risk" is minimized given the diversity in terms of type of workers and geographical distribution; (b) higher wages abroad will continue to attract Filipinos to work overseas; and (c) the aging population of industrialized countries provides the potential for a relatively younger Philippine population to fill labor gaps. Thus, we see the BSP allowing peso appreciation to reflect this reality.
The article reflects the personal opinion of the author and does not reflect the official stand of the Management Association of the Philippines. The author is director of Lazaro Bernardo Tiu & Associates and Advisor of Global Source, an international network of independent analysts (www.globalsourcepartners.com).
Tuesday, May 8, 2007
Political economy of reform
THE FINANCIAL EXECUTIVE
Business World
What elements make economic reform, especially difficult ones that involve overcoming vested interests and imposing short-term pain, possible? What is the role of leadership that is well intentioned and acting in the interest of the people? How does leadership sustain the political and social commitment to the growth process? We struggled with these and many other questions in a recent World Bank workshop in D.C., chaired by Nobel laureate and Professor Emeritus at Stanford University Michael Spence.
The workshop brought together economists and practitioners from 20 countries in Asia, Latin America, Africa, and Europe to compare notes on ongoing case studies that attempt to surface lessons from reform experiences under a wide variety of settings - historic, geographical, social, political. This is part of a broader exercise of the 21-member Commission on Growth and Development, likewise chaired by Professor Spence.
My colleague at Lazaro Bernardo Tiu & Associates, Christine Tang, and I were tasked to write and talk about the reform experience during the Ramos years, focusing on successful reform initiatives that had an important impact on Philippine growth performance.
While the reform agenda during the Ramos presidency covered much ground, including such diverse areas as investment promotion, trade liberalization, privatization, fiscal consolidation, environmental protection, and a social agenda, we chose to focus on three discrete reform efforts which were started and completed during the Ramos presidency, and which had a clear measurable impact (benefiting the country to this day). The areas that we thought illustrate well the political economy of reform and the role of leadership are:
a) Telecommunications reform. At that time, Singapore Prime Minister Lee Kuan Yew (and others) reportedly observed that "the Philippines is a country where 98% of the residents are waiting for a telephone line and the other 2% are waiting for a dial tone." Recognizing how this sad situation impeded development, the Ramos administration moved swiftly to opened up the sector to new investors such that now, with the wide use of cellular mobile phones, there is one telephone for every two Filipinos. One of the fastest growing industries in the country - business process outsourcing - would have been completely unimaginable if this reform were not done. It has also allowed "connectivity" among Filipinos everywhere, especially the more than eight million overseas Filipino that are supporting their families-and the country.
b) Oil deregulation. Prior to the reform, deficits in the Oil Price Stabilization Fund (OPSF) were a recurring problem, contributing to fiscal risk and social tensions (whenever government raised domestic pump prices). By deregulating the oil industry, and allowing new entrants and imports to come in, the Ramos administration helped insulate the vulnerable fiscal sector from the vagaries of oil prices, especially the unprecedented escalation in the last several years. Faced with the recent oil price run-up, other countries that have failed to deregulate earlier on were forced, by price pressures, to do so, not surprisingly accompanied by political disturbances.
c) Water privatization. From a water crisis situation where many households were not getting enough or continuous water supply, and many poor households were completely unconnected, the privatization of MWSS distribution (the largest water privatization in the world) has increased water coverage from 67 % of the population to 85% ( reaching outlying poorer communities) , cut non-revenue water (in the east zone) from 61% to 35% and increased average water availability from only 17 hours to 21 hours, while halting the drain of providing for this sector from the budget.
It will take much space to describe how these were done in record time by what started out as a minority presidency. Clearly though, elements of political will, vision, communication and constituency building, and astute timing to take advantage of opportunities, came into play.
Since President Ramos, continuing political turbulence has discouraged the emergence of such vision and the persistence and consistency in the pursuit of economic reforms (save for the expanded VAT, a response to a largely self-created fiscal crisis). We can only hope that as the leadership gains confidence after a credible May election, it will devote its energies, no longer to just political survival, but to leaving a lasting legacy that will drive the country's economic performance in the next decade.
In a situation where a third of the country is in absolute poverty, where job-creating domestic and foreign investments are not happening, and where hundreds of thousands are leaving the country every year in search of a better life, muddling through - made possible by workers remittances - is an unacceptable default option.
Business World
What elements make economic reform, especially difficult ones that involve overcoming vested interests and imposing short-term pain, possible? What is the role of leadership that is well intentioned and acting in the interest of the people? How does leadership sustain the political and social commitment to the growth process? We struggled with these and many other questions in a recent World Bank workshop in D.C., chaired by Nobel laureate and Professor Emeritus at Stanford University Michael Spence.
The workshop brought together economists and practitioners from 20 countries in Asia, Latin America, Africa, and Europe to compare notes on ongoing case studies that attempt to surface lessons from reform experiences under a wide variety of settings - historic, geographical, social, political. This is part of a broader exercise of the 21-member Commission on Growth and Development, likewise chaired by Professor Spence.
My colleague at Lazaro Bernardo Tiu & Associates, Christine Tang, and I were tasked to write and talk about the reform experience during the Ramos years, focusing on successful reform initiatives that had an important impact on Philippine growth performance.
While the reform agenda during the Ramos presidency covered much ground, including such diverse areas as investment promotion, trade liberalization, privatization, fiscal consolidation, environmental protection, and a social agenda, we chose to focus on three discrete reform efforts which were started and completed during the Ramos presidency, and which had a clear measurable impact (benefiting the country to this day). The areas that we thought illustrate well the political economy of reform and the role of leadership are:
a) Telecommunications reform. At that time, Singapore Prime Minister Lee Kuan Yew (and others) reportedly observed that "the Philippines is a country where 98% of the residents are waiting for a telephone line and the other 2% are waiting for a dial tone." Recognizing how this sad situation impeded development, the Ramos administration moved swiftly to opened up the sector to new investors such that now, with the wide use of cellular mobile phones, there is one telephone for every two Filipinos. One of the fastest growing industries in the country - business process outsourcing - would have been completely unimaginable if this reform were not done. It has also allowed "connectivity" among Filipinos everywhere, especially the more than eight million overseas Filipino that are supporting their families-and the country.
b) Oil deregulation. Prior to the reform, deficits in the Oil Price Stabilization Fund (OPSF) were a recurring problem, contributing to fiscal risk and social tensions (whenever government raised domestic pump prices). By deregulating the oil industry, and allowing new entrants and imports to come in, the Ramos administration helped insulate the vulnerable fiscal sector from the vagaries of oil prices, especially the unprecedented escalation in the last several years. Faced with the recent oil price run-up, other countries that have failed to deregulate earlier on were forced, by price pressures, to do so, not surprisingly accompanied by political disturbances.
c) Water privatization. From a water crisis situation where many households were not getting enough or continuous water supply, and many poor households were completely unconnected, the privatization of MWSS distribution (the largest water privatization in the world) has increased water coverage from 67 % of the population to 85% ( reaching outlying poorer communities) , cut non-revenue water (in the east zone) from 61% to 35% and increased average water availability from only 17 hours to 21 hours, while halting the drain of providing for this sector from the budget.
It will take much space to describe how these were done in record time by what started out as a minority presidency. Clearly though, elements of political will, vision, communication and constituency building, and astute timing to take advantage of opportunities, came into play.
Since President Ramos, continuing political turbulence has discouraged the emergence of such vision and the persistence and consistency in the pursuit of economic reforms (save for the expanded VAT, a response to a largely self-created fiscal crisis). We can only hope that as the leadership gains confidence after a credible May election, it will devote its energies, no longer to just political survival, but to leaving a lasting legacy that will drive the country's economic performance in the next decade.
In a situation where a third of the country is in absolute poverty, where job-creating domestic and foreign investments are not happening, and where hundreds of thousands are leaving the country every year in search of a better life, muddling through - made possible by workers remittances - is an unacceptable default option.
Tuesday, March 6, 2007
PERA - here at last
FINANCIAL EXECUTIVE
Business World
After nine long years in the making, the Personal Equity Retirement Account bill or PERA finally sees the light of day. The Capital Market Development Council, more specifically its private-sector member organizations, have long cited the benefits of PERA - tax exempt "savings for retirement" scheme patterned after similar successful ones in many countries, including the IRA in the United States.
Individuals can contribute annually up to P50,000 to such a plan and both the contributions and its interest and dividend yield will also be tax exempt provided the individual does not withdraw it sooner than age 55.
These savings schemes will be portable and properly supervised in a coordinated way by the BSP, SEC, Insurance Commission, PDIC and the BIR. PERA promises to encourage a higher level of savings, and a redirection of such toward longer- term instruments which can aid in improving the currency and maturity profile of public debt and increase the pool of resources available for projects with long recovery period such as infrastructure. It will also prompt the development of savings for retirement, especially needed for OFW's not now mandatorily covered by traditional government-sponsored institutions like the SSS and Pag-ibig.
For this we have to give credit to the father-and-son team of Senator Edgardo J. Angara, as principal architect and chair of the Senate Committee on Banks, Financial Institutions & Currencies, and Congressman Juan Edgardo M. Angara. Other senators who supported this measure are Senators Osmena, Recto, Magsaysay, Roxas and Senate President Villar. In the House of Representatives, we also have to thank Congressmen Exequiel B. Javier, Jaime C. Lopez and Herminio G. Teves.
Credit Information System Act (CISA)
Meanwhile, pending before both houses of Congress is a proposal to establish a Credit Information System which lays the basis for the collection, maintenance and distribution of credit information as well as the establishment of a Central Credit Information Corporation. The policy objectives of the bill are: (1) to establish a comprehensive and centralized credit information system in order to improve the overall availability of credit particularly to small borrowers; (2) to lower the cost of credit to responsible borrowers; and (3) to reduce excessive dependence on collateral to secure credit facilities. Underlying these objectives is the principle that the backbone of an efficiently functioning credit market rests on a reliable and accurate credit information base.
The Central Credit Information Corporation will be established as a corporate entity under the Corporation Code, with Bangko Sentral ng Pilipinas (BSP) owning up to 40% of the corporation and the rest to be held by credit-industry-related associations. The corporation will get its information from compulsory submitting entities, such as banks, their affiliates and subsidiaries as well as other credit providers that will be identified by the MB. Under the principle of reciprocity, this credit information database may be tapped or accessed by those who submitted the information - i.e., banks, their affiliates and subsidiaries. On the other hand, Special Accessing Entities like private credit bureaus and private credit rating agencies can access the database with the conformity of the borrower, and provide value-added service to their subscribers.
Borrowers are likewise allowed access to their credit information from the corporation, the Submitting Entities and Special Accessing Entities, so that they could verify the accuracy of their information. Other entities can access information from the system only upon prior consent of the borrower.
There are different models of credit information registries in other countries. Both public and private registries can be found in developed and emerging market economies. Both models rely on reciprocity or mutual information exchange, whereby the supplier of information has access to the rest of the database available in the credit bureau. It is expected that the extensive use of credit information and credit ratings will create interest in the local capital markets, e.g., for corporate bonds, as institutional investors rely on credit ratings in making investment decisions.
But more than this, small borrowers with good credit record but have no properties to put up as collaterals for their bank loans, can borrow from banks on the basis of their sound credit record. The establishment of such a system promises to do more for SMEs where the binding constraint for lending is not money but information than all of the sometimes expensive publicly funded programs for lending to SME's.
We earnestly hope that our legislators will move this vital piece of legislation during the precious few days of the resumed 14th Congress in June.
Business World
After nine long years in the making, the Personal Equity Retirement Account bill or PERA finally sees the light of day. The Capital Market Development Council, more specifically its private-sector member organizations, have long cited the benefits of PERA - tax exempt "savings for retirement" scheme patterned after similar successful ones in many countries, including the IRA in the United States.
Individuals can contribute annually up to P50,000 to such a plan and both the contributions and its interest and dividend yield will also be tax exempt provided the individual does not withdraw it sooner than age 55.
These savings schemes will be portable and properly supervised in a coordinated way by the BSP, SEC, Insurance Commission, PDIC and the BIR. PERA promises to encourage a higher level of savings, and a redirection of such toward longer- term instruments which can aid in improving the currency and maturity profile of public debt and increase the pool of resources available for projects with long recovery period such as infrastructure. It will also prompt the development of savings for retirement, especially needed for OFW's not now mandatorily covered by traditional government-sponsored institutions like the SSS and Pag-ibig.
For this we have to give credit to the father-and-son team of Senator Edgardo J. Angara, as principal architect and chair of the Senate Committee on Banks, Financial Institutions & Currencies, and Congressman Juan Edgardo M. Angara. Other senators who supported this measure are Senators Osmena, Recto, Magsaysay, Roxas and Senate President Villar. In the House of Representatives, we also have to thank Congressmen Exequiel B. Javier, Jaime C. Lopez and Herminio G. Teves.
Credit Information System Act (CISA)
Meanwhile, pending before both houses of Congress is a proposal to establish a Credit Information System which lays the basis for the collection, maintenance and distribution of credit information as well as the establishment of a Central Credit Information Corporation. The policy objectives of the bill are: (1) to establish a comprehensive and centralized credit information system in order to improve the overall availability of credit particularly to small borrowers; (2) to lower the cost of credit to responsible borrowers; and (3) to reduce excessive dependence on collateral to secure credit facilities. Underlying these objectives is the principle that the backbone of an efficiently functioning credit market rests on a reliable and accurate credit information base.
The Central Credit Information Corporation will be established as a corporate entity under the Corporation Code, with Bangko Sentral ng Pilipinas (BSP) owning up to 40% of the corporation and the rest to be held by credit-industry-related associations. The corporation will get its information from compulsory submitting entities, such as banks, their affiliates and subsidiaries as well as other credit providers that will be identified by the MB. Under the principle of reciprocity, this credit information database may be tapped or accessed by those who submitted the information - i.e., banks, their affiliates and subsidiaries. On the other hand, Special Accessing Entities like private credit bureaus and private credit rating agencies can access the database with the conformity of the borrower, and provide value-added service to their subscribers.
Borrowers are likewise allowed access to their credit information from the corporation, the Submitting Entities and Special Accessing Entities, so that they could verify the accuracy of their information. Other entities can access information from the system only upon prior consent of the borrower.
There are different models of credit information registries in other countries. Both public and private registries can be found in developed and emerging market economies. Both models rely on reciprocity or mutual information exchange, whereby the supplier of information has access to the rest of the database available in the credit bureau. It is expected that the extensive use of credit information and credit ratings will create interest in the local capital markets, e.g., for corporate bonds, as institutional investors rely on credit ratings in making investment decisions.
But more than this, small borrowers with good credit record but have no properties to put up as collaterals for their bank loans, can borrow from banks on the basis of their sound credit record. The establishment of such a system promises to do more for SMEs where the binding constraint for lending is not money but information than all of the sometimes expensive publicly funded programs for lending to SME's.
We earnestly hope that our legislators will move this vital piece of legislation during the precious few days of the resumed 14th Congress in June.
Tuesday, January 9, 2007
Despite politics
THE FINANCIAL EXECUTIVE
Business World
Macroeconomic trends over the past several months leave much to look forward to - the domestic economy has continued to grow despite the political turbulence in the early part of the year, financial markets, supported by strong capital inflows, have behaved positively, inflation rates have eased, and most importantly, the government has delivered on its promise to raise revenues and reduce its budget deficit, earning last month a stable outlook report from Moody's.
On the average, analysts predict economic growth of 4.9-5.8% in 2007. Household consumption, backed by remittances and aided by election spending, is expected to continue to underpin growth. Exports are expected to continue growing, albeit tempered by expected slower growth in advanced economies. Some election-related public infrastructure spending may also be expected. Policy-wise, the risk of going off course with respect to government's fiscal consolidation program is small as long as professional economic managers stay in charge, while monetary policy can be more flexible with the inflation rate prospectively sliding down to the 4-5% target, barring further supply shocks.
The challenge for 2007 is to transform reviving confidence into real investments, starting with sectors that have, for a while now, been expected to jump-start a fresh wave of capital accumulation - power, mining, build-operate-transfer infrastructure projects. Perhaps a demonstration of resolve to remove obstacles to doing business is required to attract the critical mass of investments needed to sustain higher growth and create jobs for the growing labor force. These obstacles are well documented in numerous studies, including those of the World Bank, and principally include, aside from macroeconomic instability, issues related to governance, i.e., corruption, voice and accountability, rule of law, as well as poor infrastructure services.
To help the course of restoring confidence eroded over the years, we can do with more examples of well- articulated and transparently executed policies and projects like the highly credible Maynilad bidding (reverting to original design of water distribution being in private sector hands) and the successful PNOC-EDC initial public offering. The opening of the NAIA Terminal 3 facility early in the year and progress in government's power privatization program can have a high immediate impact.
The positive trends notwithstanding, 2007 is an election year and the first six months will likely be lost to politics. Indeed, a highly likely scenario for 2007 would see the economy taking the backseat to politicking. The period through midyear would see investors sidelined, observing the turn of events from the elections. The greater risk to sustaining growth, however, is the administration abandoning sound economic policies (e.g., microfinance) or misspending hard-earned money on dubious expenditures (e.g., fertilizers) just to win votes.
We can nonetheless expect economic growth to proceed on momentum obtained from consumer spending and continuing exports (electronics, tourism and business process outsourcing services). Downside risks from the external sector include a sharper-than-expected slowdown in advanced economies (lowering export demand), a reversal of current trends in oil prices (stoking inflation), and global financial market volatility (complicating monetary and fiscal management).
Should election results convince the market of political and policy stability going forward, 2007 may see the economy back in the driver's seat. Should outstanding issues remain unsettled after the elections, however, the economy can be expected to continue muddling along over the medium term.
Being an optimist, I am confident that the economy's strong short-term fundamentals will continue to hold - despite porcine politics in the Year of the Pig.
Business World
Macroeconomic trends over the past several months leave much to look forward to - the domestic economy has continued to grow despite the political turbulence in the early part of the year, financial markets, supported by strong capital inflows, have behaved positively, inflation rates have eased, and most importantly, the government has delivered on its promise to raise revenues and reduce its budget deficit, earning last month a stable outlook report from Moody's.
On the average, analysts predict economic growth of 4.9-5.8% in 2007. Household consumption, backed by remittances and aided by election spending, is expected to continue to underpin growth. Exports are expected to continue growing, albeit tempered by expected slower growth in advanced economies. Some election-related public infrastructure spending may also be expected. Policy-wise, the risk of going off course with respect to government's fiscal consolidation program is small as long as professional economic managers stay in charge, while monetary policy can be more flexible with the inflation rate prospectively sliding down to the 4-5% target, barring further supply shocks.
The challenge for 2007 is to transform reviving confidence into real investments, starting with sectors that have, for a while now, been expected to jump-start a fresh wave of capital accumulation - power, mining, build-operate-transfer infrastructure projects. Perhaps a demonstration of resolve to remove obstacles to doing business is required to attract the critical mass of investments needed to sustain higher growth and create jobs for the growing labor force. These obstacles are well documented in numerous studies, including those of the World Bank, and principally include, aside from macroeconomic instability, issues related to governance, i.e., corruption, voice and accountability, rule of law, as well as poor infrastructure services.
To help the course of restoring confidence eroded over the years, we can do with more examples of well- articulated and transparently executed policies and projects like the highly credible Maynilad bidding (reverting to original design of water distribution being in private sector hands) and the successful PNOC-EDC initial public offering. The opening of the NAIA Terminal 3 facility early in the year and progress in government's power privatization program can have a high immediate impact.
The positive trends notwithstanding, 2007 is an election year and the first six months will likely be lost to politics. Indeed, a highly likely scenario for 2007 would see the economy taking the backseat to politicking. The period through midyear would see investors sidelined, observing the turn of events from the elections. The greater risk to sustaining growth, however, is the administration abandoning sound economic policies (e.g., microfinance) or misspending hard-earned money on dubious expenditures (e.g., fertilizers) just to win votes.
We can nonetheless expect economic growth to proceed on momentum obtained from consumer spending and continuing exports (electronics, tourism and business process outsourcing services). Downside risks from the external sector include a sharper-than-expected slowdown in advanced economies (lowering export demand), a reversal of current trends in oil prices (stoking inflation), and global financial market volatility (complicating monetary and fiscal management).
Should election results convince the market of political and policy stability going forward, 2007 may see the economy back in the driver's seat. Should outstanding issues remain unsettled after the elections, however, the economy can be expected to continue muddling along over the medium term.
Being an optimist, I am confident that the economy's strong short-term fundamentals will continue to hold - despite porcine politics in the Year of the Pig.
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