Fiscally challenged

THE FINANCIAL EXECUTIVE
Business World

The Philippines has become the world's poster child for fiscal consolidation, and appropriately so in many ways. Within just a few years, the country has been able to slash budget deficits, cut public debt, and reduce external vulnerability without the domestic economy having to undergo a painful recession. The degree of fiscal correction (4% of GDP in just three years) is truly exceptional for a country not yet in a fiscal or financial crisis.

Hoping to live up to its newly minted reputation, the current administration is aiming for a zero budget deficit this year, a first in over a decade. This last feat would supposedly seal investor confidence in the domestic economy and eventually bring down the risk premium attached to the country's debt.

But as most analysts agree, this year may not be the most opportune time for balancing the budget with an expected global slump and rising inflation combining to slow growth.

Not only will the spending side be affected as government feels the pressure to provide subsidies (e.g., on food and fuel) especially to the poorest segments of society, but revenues may also be placed at risk as the clamor for lower taxes intensifies.

As if on cue, the President recently remarked that a balanced budget may not be achieved this year and that creditors would understand such failure in light of emerging economic conditions and for as long as the country demonstrates a strong capacity to raise revenues. Some have mourned this pronouncement as the end of the era of fiscal consolidation. Some, however, have cheered this on as they believe that an economic slowdown, especially in a developing economy, is no time for severe fiscal restraint anyway.

However, finance officials I have talked to insist that the government remains devoted to the original fiscal program. Even as they gave no assurance that a zero deficit goal will be met, they have crowed that government has so far been able to meet its fiscal targets.

With lesser reliance on privatization sales this year, the country's tax collection agencies are expected to do the heavy lifting. In the first quarter, the Bureau of Internal Revenue (BIR) surpassed its target while the Bureau of Customs (BoC) was very close to meeting its goal. In April, the country reported a P25.8-billion budget surplus, with BIR and BOC revenues growing by about 20% and 26%, respectively.

If finance officials seem to be less concerned than expected by the effects of macroeconomic shocks this year, one only has to look at their estimated budget sensitivities to see why. According to Department of Finance (DoF) calculations, the most-feared developments today - soaring import prices, heightened inflation, and higher domestic interest costs - actually serve to improve the budget balance (e.g., through higher customs duties and larger tax revenues).

While finance officials admit these are merely first-round effects which should hold true for as long as economic activity remains robust, they say the unfavorable longer-run impact (e.g., slower growth and hence lower corporate income taxes) can be expected to emerge only after two quarters, giving them a slight buffer this year this year. The fly in the ointment appears to be the continued depreciation of the peso, and even then it is argued that net effects (rise in dollar debt payments less the increase in import taxes) will likely be negligible.

With regard to the country's long-term fiscal and economic health, it would seem that it is not so much the temporary deterioration of macro environment that we should be worried out, as the response of the government to the economic shocks as it impacts on the quality of public spending.

To date, the country is estimated to spend over P50 billion (about 1% of GDP) in food subsidies for rice price support. There is also loud clamor for a stronger buffer to the escalating costs of fuel and hence power. While it is a commendable gesture to shield the poor from increasingly harsher economic conditions, it is best that economic managers keep leakages to a minimum and prevent a distortion of incentives that may hurt productivity and adversely affect the poor in the longer run.

From a long-term perspective, a better use finances would be better quality spending with an eye to future development such as improved infrastructure, investment in health and education, and other outlays that can boost domestic efficiency. Going down this road, government's temporary fiscal policy adjustment can more widely be understood and may even be appreciated.