Business World
Fiscal results for the first quarter look a bit disturbing, with the budget deficit more than doubling in size from a year ago and already about three-fifths of the new full-year target of P199 billion (2.5% of GDP, from 0.5% originally before being raised to 1.2% then 2.2% previously). Part of this traces to a significant acceleration of public spending under the fiscal stimulus plan (e.g., infrastructure and operational outlays up by over 60% even under a reenacted budget), but part can also be attributed to a sudden decline in revenues.
Arguably, collection agencies will continue to meet difficulties in improving their performance with the economic cycle currently not working in their favor - e.g., slower nominal income growth and a plunge in imports bringing down taxes and duties. In addition, tax relief measures repackaged as components of the state's economic resiliency plan with an attached cost of P40 billion further weigh down revenue collection this year.
Notably, a couple of weeks ago, the Bureau of Customs asked the economic managers to further lower its target for the year of P277.2 billion, which was already adjusted from P317 billion previously set. First-quarter data show that the agency fell short of its program in the first three months by 16% or by 8.2 billion. On the other hand, the Bureau of Internal Revenue, whose revenue goal was lowered to P850.6 billion from P968.3 billion originally, also failed to meet its revised target of P165.3 billion in the same period by 6.4%. Authorities, likewise, cut BIR's VATcollections target this year to P196 billion from P205 billion last year.
Taking these developments into account, it will not be surprising to see the fiscal deficit as percentage of GDP reaching the neighborhood of 3% in 2009, plus some risk of it expanding. Because of structural erosion of revenues caused by changes in the tax system, it is also likely that the tax effort ratio will decline to 13.6% or possibly, even 13.3%.
There is wide acceptance of the need for a fiscal stimulus to sustain growth, however, as even credit raters and multilateral lending institutions acknowledge the merits of such a measure. The guessing game in the market now is whether or not the 3% mark will be breached because of looser spending. Risks that indeed it will just gained steam after Secretary Recto disclosed that the possibility of incurring a fiscal deficit of about P250 billion, or approximately equivalent to the marked number, is not at all remote.
High-level fiscal managers I recently conversed with say they will certainly not want the deficit to exceed 3% of GDP, which is presumably the dreaded scenario. However, there seem to be no strong assurances that spending will be reined in to pull together even a rapidly widening fiscal gap (i.e., if revenues drastically underperform). With the May 2010 elections nearing, it would be hard to imagine such fiscal tightening down the line.
This slippery slope underscores the urgency of passing more fiscal reforms as slippage would appear to place the country on an unsustainable path. The country's debt ratio had already climbed from 55.8% to 56.3% of GDP last year (though still far below the 78.2% peak half a decade ago) and may risk rising again this year on account of lower nominal growth, likely weaker primary surpluses, and a still depreciating domestic currency. Congress is considering bills on the rationalization of fiscal incentives, simplification of net income taxes, and adjustment of excise taxes (including on oil), but nearing elections may be seriously dimming the odds of their passage into law this year.
Concerns already aired by some groups about possible lack of transparency and wastage of these injections should also be noted, especially in light of the upcoming 2010 polls. As I have always argued, the best use of a fiscal stimulus in the Philippines is actually for long-term growth through the construction of much-need infrastructure (but should be "shovel- ready" to meet the near-term goal of job generation) and well-targeted spending to alleviate the plight of the poorest families while offering them incentives to improve their human capital (e.g., through conditional cash transfers).
In contrast, we need to be careful with fiscal spending with much leakage, e.g., estimated NFA deficit which last year accounted for P72 billion (1% of GDP), or of projects that have not been sufficiently studied in terms of technical aspects, economic returns and fiscal risks being assumed, especially for new large BOT projects being recently surfaced that are unlikely to be started until way after this crisis has blown over.
Quite apart from the actual drain and wastage in resources, we need to be mindful of the signaling effect on markets, including international markets for RoPs, that are still jittery. While there is some degree of market tolerance for widened deficits with the let's-get-fiscal mantra, there is also heightened concern over specific country conditions both in the external accounts and fiscal area, as we see a growing list of countries needing to go to the IMF for emergency relief since late last year (e.g., Iceland, Poland, Hungary, Georgia, Turkey, Serbia, Ukraine, Romania, Pakistan, Sri Lanka, Mexico, El Salvador, Zambia, and Kenya).
While the Philippines spreads have tightened from the highs we saw in October together with most emerging markets, holders of Philippine paper will be watching for reversal in gains in the fiscal front that can be evident from a decline in tax effort and increasing public sector debt to GDP, that is almost certain to happen this year - we all hope, within limited bounds. Sharp deterioration in these will not only affect the government's space for social and infra spending via higher debt service, but more immediately, translates to a damper on investment climate. This is especially true for the crucial banking sector, where sharp increases in the sovereign interest rates will put at risk via their holdings of government securities (on average 25% of assets), their income outlook and possibly even capital adequacy, and thus their continued ability to sustain healthy lending. "Controlled fiscal easing" (with emphasis on "controlled") as a WB friend puts it, is necessary to contain fiscal risk, especially with the prospect of slower remittance inflows in the coming months and the onset of election season later this year.
Romeo L. Bernardo is a board member of the Institute for Development and Econometric Analysis (IDEA), Inc.
