The fiscal deficit

Business World


My colleague, Ms. Margarita D. Gonzales, and I just gave an update on the Philippine fiscal picture in light of recent announcement by the Department of Finance of the end-October numbers to fund managers and holders of Philippine RoPs, who are subscribers to Global Source, a network of independent analysts. This is what I told them:
- The headline clearly is we have already breached government's full- year deficit ceiling (P250 B, 3.2% of GDP) with the year-to-date deficit already at P266.1 billion.
' The national deficit continued to widen as revenues weakened - down 7.6% yoy in October (down 4.8% Jan.-Oct.), still due to an economic slowdown and, more so, tax-reducing measures (e.g., lowered corporate income tax, minimum wage exemptions, reversion to franchise taxes in lieu of other taxes for electricity transmission).
' BIR collections declined again in October (down 5.1% yoy Jan.- Oct.) while BOC collections fell considerably during the month (down 15.7% yoy Jan-Oct ).
- The finance secretary's official comment has been that the department will continue to work harder and endeavor to be more effective in implementing our tax administration measures, hoping that Congress will also support them in their bid for revenue enhancement measures that can bring in sustainable sources of revenues for the government.
' Finance department now expects a P280 B deficit (3.6% of GDP) factoring in sale of SMC shares, but without that , about P300 B (3.8% of GDP)
- Here at GlobalSource Philippines, we are sticking to our assessment made in our last quarterly outlook report. The breach of the official target is in line with our expectations as we look to a number closer to 4% of GDP in 2009 (about P310 B).
- Unfortunately, there is little hope now for narrowing this year' s fiscal gap:
' One, because of the recent typhoons/floods, collections can be expected to weaken further (with calamity losses tax-deductible and possibly some leniency for humanitarian reasons) while there is now even greater pressure for the government to continue spending (for reconstruction and rehabilitation).
' Two, the touted improvement in administrative measures are not expected to add that much to the equation.
' Three, the SMC sale, expected to yield P50 billion or almost one percent of GDP, which is what the government is banking on, involves legal hurdles over ownership. This is a case that has been pending for years, and unlikely to be decided before yearend.
' Also, prospects are weak for other planned privatizations judged by the recent bid failure of a Metro Manila property (FTI complex in Taguig) and the loud protestations by politicians over alleged possible midnight asset sales by an outgoing administration (including protests over the sale of a supposedly hicstorical property in Fujima, Japan).
' Finally, we already see a narrowing (if not closed) window for passage of tax reforms (especially new measures) over the next few months given the May 2010 elections. In fact, it would be best if nothing comes out of this Congress. Why? Given we are already in election season, the risk is that what comes out will be the exact opposite of what is needed as what happened with the Comprehensive Tax Reform package in 1995.
y A good example of a bad measure is recently proposed legislation by an influential congressman, which seems to have the support of the finance secretary, to encourage voluntary advance tax payments to generate P100 billion for flooding reconstruction by offering a discount to the taxpayers. This kind of revenue anticipation, apart from causing confusion in government finance statistics time series data, can only cost government more than if it simply borrowed from a very liquid debt market. Clearly, for taxpayers to find this attractive, the discount government needs to give will have to be at least equal to taxpayers' cost of borrowing, which is much higher than government's own cost of borrowing.
- Now, let us let us look at the prospects for 2010:
' We note that government is sticking to its existing deficit target (P233.4 B, 2.8% of GDP).
' We however are not so optimistic that this is achievable (will likely still breach 3% of GDP given the circumstances, e.g., still tepid growth, lack of needed new tax measures).
' Notably, the tax effort ratio could shrink to pre-2006 levels this year, i.e., the range just prior to the introduction of the expanded VAT, and significant improvement will definitely require that new fiscal reform measures be implemented.
- But, as we had stated in our latest quarterly report, we aren't that worried about the impact on financial markets for a few reasons:
' The continued high level of remittances (up 8.6% in Sep, up 4.2% Jan-Sep, defying previous expectations of a decline) as a robust current account allows a healthy amount of dollar borrowing (enough to calm the peso bond market, and allowing even a pre- funding of next year's requirements) while keeping liquidity conditions loose.
' A deficit of the size currently expected has already been factored in by the markets for 2009 with the consensus that such is manageable.
' Though the deficit will likely not narrow by much next year, it would still be an improvement over this year's fiscal gap ;and we have greater hopes that reform measures can be successfully pushed with the entry of a new and more popular administration.
- In short, while emerging fiscal concerns are certainly daunting with the poor state of government finances and embedded revenue and spending millstone, the new political environment gives us a promising window to animate the country/economy and improve growth potentials over the next six years helping the new government to achieve hoped-for medium-term fiscal consolidation (i.e., reining in future deficits and bringing the debt ratio back on a downward trajectory).
Mr. Romeo Bernardo is Global Source Philippine advisor and board member of The Institute for Development and Econometric Analysis, Inc. He was formerly undersecretary of Finance during the Aquino and Ramos administrations.