Monday, December 20, 2010
Taxing matters
Business World
Introspective
The Bureau of Internal Revenue has posted in its Web page the list of its top 500 individual taxpayers. It is unclear to me what public purpose is achieved by posting such a list. What is clear is that it may have caused unfair and unnecessary unease for both those on and out of the list.
For those on the list, continuing public Web page access to the information is cause for worry that this provides easy reference for every donation seeker, scam artist, or even worse.
Those affluent but absent were not spared, for most undeservedly, as the list provided fodder for gratuitous speculation. One broadsheet asked provocatively in its front page why this or that prominent top executive or businessman was not on the large taxpayer list; as did at least one priest's Sunday sermon I heard about.
There can be several reasons why one who is rich or earning well may not appear on the list, none having anything to do with lack of fidelity in paying one's taxes. For many top executives, the company withholds and pays their individual income taxes directly to the BIR under a procedure known as substituted filing.
Provided the individual has only that single source of still taxable income, he does not need to file an income tax return. These substituted filings were likely not captured by the BIR's top 500 list.
Then there are cases of individuals who have incorporated their business, such that the income is earned by the corporation, which then pays the appropriate corporate income taxes. Additionally, the dividend income the individual derives from the corporation is levied a final tax collected at source. There is no requirement that this be subject of an individual income tax filing. This is true as well for those whose income is passive, i.e., derived primarily from interest and dividends, which are imposed final taxes withheld at source. These are not captured in BIR's top 500.
These limitations in the data were not adequately explained by the BIR, either in their post or in public pronouncements. Thus rather than shaming tax evaders which may have been the object of the top 500 exercise, the issuance of such a list without qualification may have just provoked people to unfairly rail against those prominently known but absent from the list but who are already in BIR's tax net and faithfully paying their taxes.
One has to question the wisdom of continuing with such a list, which achieves no apparent public purpose, but just puts listed large individual taxpayers at risk from criminal elements, and unlisted law- abiding ones at risk of unfair shaming by the uninformed. If the BIR insists on continuing with this practice, the least it can do is to remove the amount of taxes paid in the interest of safety of the taxpayer and his family. For my part, I truly doubt that the large tax evaders and smugglers, who are completely outside the tax agencies' data base as they do not issue receipts or file returns, can be shamed into paying proper taxes. The current leadership truly needs to break away from the past practice of simply hunting in the zoo and go after voracious wildlife - not an easy tax at all.
To be fair, the new leadership in the DoF and the BIR is demonstrating amazingly admirable determination to raise revenue collections through various programs. I applaud them vigorously. Their work is made difficult by structural erosion in the revenue base due to non-indexation of excise taxes, as well as the passage of tax-eroding laws in the last two years, by one estimate costing over 1 % of GDP annually (P80 billion).
Administrative measures, however, can only do so much, based on both our own and international experience. It does not help that the new administration came in under a campaign promise of no new or increase in taxes even as it is under pressure to do catch-up infrastructure and social spending.
Perhaps in an effort to help increase revenues while staying faithful to the administration campaign promise, Rep. Dodong Mandanas, chairman of the House Ways and Means Committee is pushing hard for a Value Simplified Tax ( VAST) at 6% to replace the 12% VAT. Despite opposition from the Department of Finance and known experts in the field, this has recently passed his committee. I share the reservations of critics of VAST, a multi-stage turnover tax that cascades, i.e., imposed on a product several times depending on the number of stages involved throughout the production and distribution chain. As the DoF position paper states: adopting a lower rate of 6 % for VAST can be deceiving and the poor who is largely limited to purchasing goods from a retail store could end up paying more than the rich. The paper also argues persuasively that in addition to being not transparent (which could actually be its major selling point) it distorts production and resource allocation, as well as impacting unfavorably on exports. (The public can derive comfort from the pronouncements of Senate Ways and Means Committee Chairman Sen. Ralph Recto that he does not favor the VAST for the reasons cited. )
If not VAST, what then to improve the fiscal picture and finance needed development spending? UP Professors Canlas, Diokno, and Medalla, in a fiscal road map, they drew up before the presidential elections, put forward the following measures: a) reform of fiscal incentives, b) reform of excise taxes on cigarettes and liquor, c) increase in VAT to 15 % while lowering personal and corporate income taxes to 25%, d) a higher taxes on fuel products. (See my column, Fiscal imperative for next administration, Oct 5, 2009)
Even as the fiscal leadership perseveres in trying to collect more from the existing tax base, it should perhaps quietly constitute an experts study group to do a comprehensive review of our tax system and recommend reforms adapted to changing complexion of the Philippine economy and its financing needs.
Mr. Romeo Bernardo is managing director of Lazaro Bernardo Tiu & Associates, Inc. (a consultancy firm), board member of The Institute for Development and Econometric Analysis, Inc, and was undersecretary of Finance during the Aquino1 and Ramos administrations.
Monday, December 6, 2010
Did peace bonds disadvantage gov't?
Business World
Introspective
The Peace Bonds have become a live issue again with the 10-year bonds maturing early next year. The analysis (below) of the Foundation for Economic Freedom in 2002 came to the conclusion that taxpayers were not disadvantaged. This paper is an abridged version of what was drafted by former FEF President Francis Varela, FEF Chairman Philip Medalla, and myself.
Critics have alleged that there was an anomaly involved in the sale of the P1.4-billion Peace Bonds, allowing CODE-NGO to generate a fantastic windfall and leading to significant losses on the part of government. To our mind, the key question toward developing a dispassionate and rational perspective on the whole issue is:
What was the appropriate value of these bonds when they were issued in October last year?
First, the pertinent facts:
The Bureau of Treasury sold (through a bidding process) 10-year zero- coupon bonds with a face value of P35 billion to a bank (RCBC) which acted on behalf of CODE-NGO. The bonds were sold at a total price of P10.2 billion, thus implying a yield of 12.75% per annum. The bonds are effectively tax exempt and eligible as liquidity reserves for banks and quasi-banking institutions. Simultaneously, or within a very short period of time, CODE-NGO sold the bonds to RCBC Capital at a gross profit of P1.8 billion or a total consideration of P12.0 billion. At this price, the implied yield of the bonds to the end-buyer (RCBC Capital) goes down from 12.75% to only 11 percent.
Was the appropriate value of the bonds upon issuance P10.2 billion or P12.0 billion? Or, alternatively, was the appropriate yield of the bonds 12.75% or 11%?
We have to note that the difference between the two yields is very significant and non-trivial in a reasonably efficient financial market. Thus, if this wide a yield movement takes place without the occurrence of a major market-shaking event, then the conclusion is that either the issuer paid too high a yield or the final buyer overpaid for the bond and is now suffering below-market yields. As the Philippine financial market was relatively calm when the Peace Bonds were auctioned, clearly, therefore, one of the yields was wrong.
If 11% was indeed the appropriate yield for the bonds, then the Department of Finance/Bureau of Treasury committed a serious mistake in the sale of the bonds and were remiss in their duty to protect the interests of government. Notwithstanding the openness of the auction and without having to allege that it was rigged, one could nevertheless argue that they should have devoted more time and effort explaining the features of the bond to more market participants in order to achieve the lower yield. If this were the case, then the critics are right and we, as taxpayers, should all join in condemning the issue as a major anomaly.
On the other hand, if the appropriate yield of the bonds was 12.75%, then clearly there could have been no anomaly involving government funds and the only logical conclusion is that RCBC overpaid for the bonds, and the extraordinary profit enjoyed by CODE-NGO could not have come from government.
We now proceed to analyze the features of the bond to determine its appropriate value. First, we would like to note that the main features that enhanced the value of the bond were the tax exemption and the liquidity reserve eligibility. Second, we also wish to note that the zero-coupon feature did not add any value to the bond. Normally, a zero-coupon bond issued by the same issuer and with the same tenor would trade at a slightly higher yield than an ordinary coupon-bearing bond.
Thus, conservatively (from the issuer's standpoint) we can compare the Peace Bonds with the regular 10-year Treasury note. At the time of the auction, the regular 10-year T-notes were trading in the secondary market at a yield of 16.9%. Since the regular 10-year T-note is subject to the 20% final withholding tax, the after-tax yield of the 10- year T-note was 13.5%. Thus, if the Peace Bonds had no other enhancement aside from the tax exemption, then it should have traded at around 13.5% or higher, not 12.75% and DEFINITELY NOT 11%. On the other hand, considering that the difference between the regular T-bills and the reserve eligible ones is only 0.5%, then the fair yield of the Peace Bonds was approximately 13%.
Based on the foregoing, it is our conclusion that the 12.75% original yield of the Peace Bonds was favorable to government and that it was RCBC, not government, that bore the cost of the P1.8-billion windfall that was enjoyed by CODE-NGO by suffering an inordinately low yield on this instrument when they bought the bonds on a secondary basis from CODE-NGO. Whether this resulted from philanthropy and social spirit, miscalculation or contractual constraints that required RCBC to provide fees to CODE-NGO even in a transparently bid auction where they would have been entitled to participate anyhow, or a combination of the above, is a private matter.
Now, looking at this issue in its entirety, we believe that it was inappropriate, if not outright wrong, for CODE-NGO to have attempted to conduct this transaction on a negotiated basis, as they themselves have admitted. We believe it is fair to surmise that, if there was no auction, the government would have ended having to bear the cost of the CODE-NGO windfall. Thus, instead of being pilloried and maligned, the DOF and the BTr deserve our congratulations and commendation for having resisted the strong overtures of CODE-NGO to conduct a negotiated sale. In particular, we have to thank Treasurer Sergio Edeza for having been so clear and unswerving in his position on the matter, and for taking only the highest interest of the Republic into account in his actions. Clearly, the government did not lose a single centavo in the transaction, thanks to their efforts.
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.
Introspective
The Peace Bonds have become a live issue again with the 10-year bonds maturing early next year. The analysis (below) of the Foundation for Economic Freedom in 2002 came to the conclusion that taxpayers were not disadvantaged. This paper is an abridged version of what was drafted by former FEF President Francis Varela, FEF Chairman Philip Medalla, and myself.
Critics have alleged that there was an anomaly involved in the sale of the P1.4-billion Peace Bonds, allowing CODE-NGO to generate a fantastic windfall and leading to significant losses on the part of government. To our mind, the key question toward developing a dispassionate and rational perspective on the whole issue is:
What was the appropriate value of these bonds when they were issued in October last year?
First, the pertinent facts:
The Bureau of Treasury sold (through a bidding process) 10-year zero- coupon bonds with a face value of P35 billion to a bank (RCBC) which acted on behalf of CODE-NGO. The bonds were sold at a total price of P10.2 billion, thus implying a yield of 12.75% per annum. The bonds are effectively tax exempt and eligible as liquidity reserves for banks and quasi-banking institutions. Simultaneously, or within a very short period of time, CODE-NGO sold the bonds to RCBC Capital at a gross profit of P1.8 billion or a total consideration of P12.0 billion. At this price, the implied yield of the bonds to the end-buyer (RCBC Capital) goes down from 12.75% to only 11 percent.
Was the appropriate value of the bonds upon issuance P10.2 billion or P12.0 billion? Or, alternatively, was the appropriate yield of the bonds 12.75% or 11%?
We have to note that the difference between the two yields is very significant and non-trivial in a reasonably efficient financial market. Thus, if this wide a yield movement takes place without the occurrence of a major market-shaking event, then the conclusion is that either the issuer paid too high a yield or the final buyer overpaid for the bond and is now suffering below-market yields. As the Philippine financial market was relatively calm when the Peace Bonds were auctioned, clearly, therefore, one of the yields was wrong.
If 11% was indeed the appropriate yield for the bonds, then the Department of Finance/Bureau of Treasury committed a serious mistake in the sale of the bonds and were remiss in their duty to protect the interests of government. Notwithstanding the openness of the auction and without having to allege that it was rigged, one could nevertheless argue that they should have devoted more time and effort explaining the features of the bond to more market participants in order to achieve the lower yield. If this were the case, then the critics are right and we, as taxpayers, should all join in condemning the issue as a major anomaly.
On the other hand, if the appropriate yield of the bonds was 12.75%, then clearly there could have been no anomaly involving government funds and the only logical conclusion is that RCBC overpaid for the bonds, and the extraordinary profit enjoyed by CODE-NGO could not have come from government.
We now proceed to analyze the features of the bond to determine its appropriate value. First, we would like to note that the main features that enhanced the value of the bond were the tax exemption and the liquidity reserve eligibility. Second, we also wish to note that the zero-coupon feature did not add any value to the bond. Normally, a zero-coupon bond issued by the same issuer and with the same tenor would trade at a slightly higher yield than an ordinary coupon-bearing bond.
Thus, conservatively (from the issuer's standpoint) we can compare the Peace Bonds with the regular 10-year Treasury note. At the time of the auction, the regular 10-year T-notes were trading in the secondary market at a yield of 16.9%. Since the regular 10-year T-note is subject to the 20% final withholding tax, the after-tax yield of the 10- year T-note was 13.5%. Thus, if the Peace Bonds had no other enhancement aside from the tax exemption, then it should have traded at around 13.5% or higher, not 12.75% and DEFINITELY NOT 11%. On the other hand, considering that the difference between the regular T-bills and the reserve eligible ones is only 0.5%, then the fair yield of the Peace Bonds was approximately 13%.
Based on the foregoing, it is our conclusion that the 12.75% original yield of the Peace Bonds was favorable to government and that it was RCBC, not government, that bore the cost of the P1.8-billion windfall that was enjoyed by CODE-NGO by suffering an inordinately low yield on this instrument when they bought the bonds on a secondary basis from CODE-NGO. Whether this resulted from philanthropy and social spirit, miscalculation or contractual constraints that required RCBC to provide fees to CODE-NGO even in a transparently bid auction where they would have been entitled to participate anyhow, or a combination of the above, is a private matter.
Now, looking at this issue in its entirety, we believe that it was inappropriate, if not outright wrong, for CODE-NGO to have attempted to conduct this transaction on a negotiated basis, as they themselves have admitted. We believe it is fair to surmise that, if there was no auction, the government would have ended having to bear the cost of the CODE-NGO windfall. Thus, instead of being pilloried and maligned, the DOF and the BTr deserve our congratulations and commendation for having resisted the strong overtures of CODE-NGO to conduct a negotiated sale. In particular, we have to thank Treasurer Sergio Edeza for having been so clear and unswerving in his position on the matter, and for taking only the highest interest of the Republic into account in his actions. Clearly, the government did not lose a single centavo in the transaction, thanks to their efforts.
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.
Monday, October 25, 2010
Coping with surges: Unlikely controls
Business World
Introspective
In the current scenario, with low forecast inflation, we are more convinced that monetary authorities will refrain from hiking policy rates until the end of the year because this could encourage further speculative flows. We believe, however, that it is highly unlikely that they will turn to capital controls despite Asian neighbors doing so except as a last resort.
There are several reasons behind the latter view. One is the BSP's consistent behavior in recent history as it allowed the exchange rate to appreciate sharply in the face of strong dollar flows. The last such episode had only been a couple of years ago when the peso was allowed to rise in value dramatically from near P50/$ in 2007 to about P40/$ by early 2008 citing a mandate to limit exchange rate volatility but not dictate trend.
Another is the belief of monetary authorities as reflected in a recently updated primer that such measures are costly to implement and likely ineffective in the long run as ways to circumvent them can be found. Past experience of the country with controls had not been pleasant (i.e., on FX, for most periods between the 1950s until 1992), as these had been difficult to administer and prone to abuse.
An aversion to capital controls remains, with the central bank fearing that re-imposition of barriers would discourage investors, weaken access to international capital markets, and hinder the ability to attract foreign investments. Not too long ago, in December 2006, fellow inflation targeter Thailand effectively taxed foreign portfolio investors by requiring unremunerated reserves, a policy move that led to a surge in stock volatility and a 15% fall in Thai equities in a single day. (N.B. This was reimposed a couple of days ago.)
Monetary policy makers typically argue that remittances and export receipts dominate foreign exchange inflows such that peso movements had fundamental basis, voiding the issue of currency overvaluation. While it is known that even fundamentally sound flows can precipitate asset booms and busts in certain sectors, they aver that peaks seen today in the local equities market hardly constitute a bubble. In the real estate sector, there is also no rapid escalation of prices so far with demand coming mostly from end-users, mainly overseas workers' families; with transactions involving contracts to sell rather than contracts of sale, meaning the property remains in the name of the seller until fully paid; and with the institutional financing setup discouraging excessive risk taking.
Other solutions to prevent the collateral impact of large capital flows are being offered by the BSP such as the use of macro-prudential regulations to prevent bubbles and administrative measures to encourage FX outflows. In addition, Mr. Guinigundo said the BSP can carefully calibrate monetary policy, balancing the need to tighten liquidity and reduce risk appetite to short an otherwise full bubble situation against the possibility of higher interest rates further attracting hot money.
To appease dollar earners who were hurting from a strong peso in 2007, steps then taken by the central bank included retiring external debt, encouraging national government to alter its financing mix or prepay debt, and liberalizing the foreign exchange system (e.g., allowing banks to take a larger overbought position) apart from some accumulation of reserves, including FX swaps. Such measures will likely be again pushed if peso strength persists.
This column was taken from the Oct. 1 report of the author and Margarita D. Gonzales. Both are advisors of GlobalSource, a New York-based network of independent analysts. Mr. Bernardo is also a board director of IDEA, the Institute for Development and Econometric Analysis.
Introspective
In the current scenario, with low forecast inflation, we are more convinced that monetary authorities will refrain from hiking policy rates until the end of the year because this could encourage further speculative flows. We believe, however, that it is highly unlikely that they will turn to capital controls despite Asian neighbors doing so except as a last resort.
There are several reasons behind the latter view. One is the BSP's consistent behavior in recent history as it allowed the exchange rate to appreciate sharply in the face of strong dollar flows. The last such episode had only been a couple of years ago when the peso was allowed to rise in value dramatically from near P50/$ in 2007 to about P40/$ by early 2008 citing a mandate to limit exchange rate volatility but not dictate trend.
Another is the belief of monetary authorities as reflected in a recently updated primer that such measures are costly to implement and likely ineffective in the long run as ways to circumvent them can be found. Past experience of the country with controls had not been pleasant (i.e., on FX, for most periods between the 1950s until 1992), as these had been difficult to administer and prone to abuse.
An aversion to capital controls remains, with the central bank fearing that re-imposition of barriers would discourage investors, weaken access to international capital markets, and hinder the ability to attract foreign investments. Not too long ago, in December 2006, fellow inflation targeter Thailand effectively taxed foreign portfolio investors by requiring unremunerated reserves, a policy move that led to a surge in stock volatility and a 15% fall in Thai equities in a single day. (N.B. This was reimposed a couple of days ago.)
Monetary policy makers typically argue that remittances and export receipts dominate foreign exchange inflows such that peso movements had fundamental basis, voiding the issue of currency overvaluation. While it is known that even fundamentally sound flows can precipitate asset booms and busts in certain sectors, they aver that peaks seen today in the local equities market hardly constitute a bubble. In the real estate sector, there is also no rapid escalation of prices so far with demand coming mostly from end-users, mainly overseas workers' families; with transactions involving contracts to sell rather than contracts of sale, meaning the property remains in the name of the seller until fully paid; and with the institutional financing setup discouraging excessive risk taking.
Other solutions to prevent the collateral impact of large capital flows are being offered by the BSP such as the use of macro-prudential regulations to prevent bubbles and administrative measures to encourage FX outflows. In addition, Mr. Guinigundo said the BSP can carefully calibrate monetary policy, balancing the need to tighten liquidity and reduce risk appetite to short an otherwise full bubble situation against the possibility of higher interest rates further attracting hot money.
To appease dollar earners who were hurting from a strong peso in 2007, steps then taken by the central bank included retiring external debt, encouraging national government to alter its financing mix or prepay debt, and liberalizing the foreign exchange system (e.g., allowing banks to take a larger overbought position) apart from some accumulation of reserves, including FX swaps. Such measures will likely be again pushed if peso strength persists.
This column was taken from the Oct. 1 report of the author and Margarita D. Gonzales. Both are advisors of GlobalSource, a New York-based network of independent analysts. Mr. Bernardo is also a board director of IDEA, the Institute for Development and Econometric Analysis.
Monday, October 18, 2010
Coping with surges
Business World
Introspective
While hot money has been flowing heavily into emerging market economies this year, it was only in the last couple of weeks that the Philippines started to feel a surge in capital. Now at the front end of the receiving line, the relatively small Philippine Stock Exchange has become the second-best performer in Asia, with the main index (the PSEi) already surpassing its peak in 2007 and, much earlier than foreseen, broken the critical 4000 mark by mid-September.
Strong demand has been fueled in large measure by foreign buying as abundant global liquidity due to quantitative easing in advanced economies naturally sought higher returns in emerging markets. The optimism has also been partly due to a surprisingly buoyant domestic economy and, to some extent, a new leadership after a period of uncertainty lowering political risk.
Apart from equities, foreign money has also flowed into government paper lured by interest differentials, where registered portfolio investment in peso securities grew by 38% in the first half to nearly $1 billion. The country's first global peso issue early in September likewise served as a magnet for funds, bringing in another $1 billion equivalent. Just a few days ago, the government swapped existing Philippine global bonds (ROPs) with securities of later maturity that were either reopened or newly minted, with the new issuances also sold for cash (about $200 million).
The result of these forces has been an even stronger peso, with the exchange rate now falling below P44/$. Unless another major downturn occurs in the world economy or the domestic fiscal situation gets out of hand, peso appreciation can be expected to continue and, in our view, drop to about P43/$ by yearend.
Assets denominated in local currency may remain attractive owing to continued strength of overseas Filipinos' remittances and a still rapidly rising export haul of BPO firms providing support to the peso. Despite a steep trajectory in stock prices, there remains room for improvement as the local bourse's price-earnings ratio still lies at the middle of the range historically and compared with other bourses in the region while forecasts of corporate profitability remain high.
To fund the national deficit, the government is expected to issue more global peso bonds which have proven to be attractive to foreign investors compared with domestic peso issuances because of ease of trading, absence of withholding taxes and offshore dollar settlement. Meanwhile, global capital moving away from advanced markets may go on combing through emerging markets for higher profit potentials.
'Complications'
As global capital has funneled into emerging markets, capital controls have suddenly become respectable, especially with the IMF lately acknowledging that such measures can be a legitimate part of the tool kit to manage capital inflows under certain circumstances. Asian economies that have experimented with controls include South Korea, which placed limits on the buildup of FX derivatives last June to reduce the risk of capital reversals, and Indonesia, which adopted measures at about the same time to discourage short-term fixed-income investment.
With risk appetites seemingly back after waning temporarily due to the euro zone sovereign debt crisis, some of the hot money flows has now also headed the way of the Philippines. After the US Fed announced last week that it was keeping the Fed's fund rate close to zero, Bangko Sentral ng Pilipinas (BSP) Governor Amando Tetangco said monetary authorities were aware that interest differentials remained in favor of emerging market economies and acknowledged that this could complicate monetary policy.
While the Philippines had already shifted to inflation targeting given the futility of trying to manage the exchange rate while simultaneously controlling domestic liquidity, difficulties remain in dealing with large capital flows, particularly given the negative impact of a strong peso on exporters and overseas workers' families. The BSP still has to walk a fine line between smoothing fluctuations in the exchange rate and keeping inflation within target.
In an e-mail exchange, Deputy Governor Diwa Guinigundo shared with us that while a sustained capital surge could lead to excessive liquidity creating inflationary pressure and asset price bubbles, the BSP was not overly concerned because the magnitude remains manageable. He believes inflows have even helped the central bank manage inflation by supporting peso appreciation, while low inflation helped partially restore competitiveness.
Monday, September 13, 2010
Beyond 'obscene' GOCC compensation
Business World
Introspective
Much media space and Congress energies have been devoted to the scandalously high compensation provided by the Arroyo administration to its officials in some GOCCs, especially for those in corporations perceived to have performed poorly like the SONA-mention-worthy MWSS.
While such indignation is not misplaced, such wastes are perhaps in most cases dwarfed by social and economic costs to the country of poor governance due to poorly defined missions, political interventions, corruption, and incompetence.
I would put under that category, NFA, which, even if it has not been an overly generous employer relative to others we read about in the papers, managed to lose P 100 billion in two years while achieving little.
According to a World Bank study, for every P5 of subsidy that the taxpayer pays, only P1 is realized as having social benefit, and the balance, just wasted, or diverted.
Many of us, I think, will be quite happy to pay Singapore-level compensation for GOCCs, if they can perform like Singapore public entities. Thus, I have absolutely no qualms about what some may see as relatively high pay of management of the BSP, an institution which has earned the respect of both international and financial community as being in its own class in this country.
So, the point to underscore beyond the headlines of obscene compensation is performance. In fact, in the case of the BSP, its financial independence and good-pay structure is perhaps part of the story behind good-governance structures, one that allows the recruitment and retention of good people, and the development of a cadre of professionals with a long-term commitment to their organization's well-defined mission under its charter (and who are continuously challenged by financial stresses both local and global).
Clearly though, pay is only part of the story. The other elements of its good-governance story include historical good leadership, a well- defined mandate, having an incentive structure in the organization that is aligned with its mission and insulated from bad politics and conducive to adopting best practices of like institutions globally.
The other government corporations under public klieg lights in terms of pay are GFIs, especially the two pension institutions - SSS and GSIS. In 2006, I had the privilege of being part of a team of international consultants commissioned by the World Bank and the Department of Finance to look at the structural and governance weaknesses of government pension institutions so that they can perform better. (The team included Estelle James, a well-known expert and author of a standard reference on the subject: Averting the Old Age Crisis: Policies to Protect the Old and Promote Growth)
The cost to the economy of their poor performance manifests in the risks they pose to the fiscal sector, since pension benefit liabilities are guaranteed by the national government. We have only to remember the bad investments that GSIS made in the 1970s in many enterprises (like PAL, Manila Hotel, etc.) that ended up being loaded on the Department of Finance auction block and the bankruptcy of RSBS and the resultant reversion of all of the pension-servicing responsibilities of the military back to the national government a few years ago. And who can forget the documented involvement in stock-market manipulation that was part of the charges that led to the impeachment of President Estrada? Eyebrows were raised as well by their participation in high-profile corporate boardroom struggles as well as general concern that these two heavyweights, in playing the stock market, were a cause of major distortions. Most recently we were dismayed by reported huge investments of Home Development Fund/Pag-ibig, in questionable mortgage papers of a development company that they have recently blacklisted, in what seems like a case of shutting the barn door after the horses have bolted.
Our final report, almost 200 pages without annexes, was submitted to the sponsors in March 2007, and may be available upon request.
Allow me to list just a few its key recommendations:
1. Governance institutions need to be strengthened: Members of the SSS Commission, GSIS Board of Trustees should have clear fiduciary responsibility to make decisions solely in the interest of members, and should be chosen through a selection process that ensures professionalism and protection from political interference. (Rural bank directors have to be vetted by the BSP to be fit and proper, but not these pension institutions.) A professional Investment Board should be formed for each institution, to take specific investment decision under the broad investment strategy set by the governing board.
2. Investment processes should be strengthened through the adoption of explicit investment policies that set objectives regarding returns, risk management, types of assets to guide specific investment decisions. Institutions should solicit outside professional investment advice and independent asset managers and custodians should be used.
3. Investment portfolios should be better diversified, including internationally to go beyond the relatively small Philippine capital markets. Domestically, equity investments should be shifted toward pooled instruments such as an allocation matching the Philippine Stock market index, thereby reducing influence on specific share prices and avoiding the need to place members in corporate board of directors.
4. Supervision should be unified and strengthened. A new Insurance and Pension Commission, built on the foundation of the current Insurance Commission, should supervise SSS. GSIS, Pag-ibig, all private pension schemes and any similar instruments.
5. The government should consider the merits of a universal or needs- based pension, paid from general state revenues, to complement existing pension programs, in order to expand coverage and reduce elderly poverty.
6. Pension reform needs to fit into a context of overall financial sector development.
The new leadership in these institutions as well as in the Department of Finance should take a look at how they can address the governance and structural weaknesses in these institutions in a lasting manner.
Mr. Romeo Bernardo is managing director of Lazaro Bernardo Tiu & Associates, Inc. (a consultancy firm), board member of The Institute for Development and Econometric Analysis, Inc, and was undersecretary of Finance during the Aquino 1 and Ramos administrations.
Introspective
Much media space and Congress energies have been devoted to the scandalously high compensation provided by the Arroyo administration to its officials in some GOCCs, especially for those in corporations perceived to have performed poorly like the SONA-mention-worthy MWSS.
While such indignation is not misplaced, such wastes are perhaps in most cases dwarfed by social and economic costs to the country of poor governance due to poorly defined missions, political interventions, corruption, and incompetence.
I would put under that category, NFA, which, even if it has not been an overly generous employer relative to others we read about in the papers, managed to lose P 100 billion in two years while achieving little.
According to a World Bank study, for every P5 of subsidy that the taxpayer pays, only P1 is realized as having social benefit, and the balance, just wasted, or diverted.
Many of us, I think, will be quite happy to pay Singapore-level compensation for GOCCs, if they can perform like Singapore public entities. Thus, I have absolutely no qualms about what some may see as relatively high pay of management of the BSP, an institution which has earned the respect of both international and financial community as being in its own class in this country.
So, the point to underscore beyond the headlines of obscene compensation is performance. In fact, in the case of the BSP, its financial independence and good-pay structure is perhaps part of the story behind good-governance structures, one that allows the recruitment and retention of good people, and the development of a cadre of professionals with a long-term commitment to their organization's well-defined mission under its charter (and who are continuously challenged by financial stresses both local and global).
Clearly though, pay is only part of the story. The other elements of its good-governance story include historical good leadership, a well- defined mandate, having an incentive structure in the organization that is aligned with its mission and insulated from bad politics and conducive to adopting best practices of like institutions globally.
The other government corporations under public klieg lights in terms of pay are GFIs, especially the two pension institutions - SSS and GSIS. In 2006, I had the privilege of being part of a team of international consultants commissioned by the World Bank and the Department of Finance to look at the structural and governance weaknesses of government pension institutions so that they can perform better. (The team included Estelle James, a well-known expert and author of a standard reference on the subject: Averting the Old Age Crisis: Policies to Protect the Old and Promote Growth)
The cost to the economy of their poor performance manifests in the risks they pose to the fiscal sector, since pension benefit liabilities are guaranteed by the national government. We have only to remember the bad investments that GSIS made in the 1970s in many enterprises (like PAL, Manila Hotel, etc.) that ended up being loaded on the Department of Finance auction block and the bankruptcy of RSBS and the resultant reversion of all of the pension-servicing responsibilities of the military back to the national government a few years ago. And who can forget the documented involvement in stock-market manipulation that was part of the charges that led to the impeachment of President Estrada? Eyebrows were raised as well by their participation in high-profile corporate boardroom struggles as well as general concern that these two heavyweights, in playing the stock market, were a cause of major distortions. Most recently we were dismayed by reported huge investments of Home Development Fund/Pag-ibig, in questionable mortgage papers of a development company that they have recently blacklisted, in what seems like a case of shutting the barn door after the horses have bolted.
Our final report, almost 200 pages without annexes, was submitted to the sponsors in March 2007, and may be available upon request.
Allow me to list just a few its key recommendations:
1. Governance institutions need to be strengthened: Members of the SSS Commission, GSIS Board of Trustees should have clear fiduciary responsibility to make decisions solely in the interest of members, and should be chosen through a selection process that ensures professionalism and protection from political interference. (Rural bank directors have to be vetted by the BSP to be fit and proper, but not these pension institutions.) A professional Investment Board should be formed for each institution, to take specific investment decision under the broad investment strategy set by the governing board.
2. Investment processes should be strengthened through the adoption of explicit investment policies that set objectives regarding returns, risk management, types of assets to guide specific investment decisions. Institutions should solicit outside professional investment advice and independent asset managers and custodians should be used.
3. Investment portfolios should be better diversified, including internationally to go beyond the relatively small Philippine capital markets. Domestically, equity investments should be shifted toward pooled instruments such as an allocation matching the Philippine Stock market index, thereby reducing influence on specific share prices and avoiding the need to place members in corporate board of directors.
4. Supervision should be unified and strengthened. A new Insurance and Pension Commission, built on the foundation of the current Insurance Commission, should supervise SSS. GSIS, Pag-ibig, all private pension schemes and any similar instruments.
5. The government should consider the merits of a universal or needs- based pension, paid from general state revenues, to complement existing pension programs, in order to expand coverage and reduce elderly poverty.
6. Pension reform needs to fit into a context of overall financial sector development.
The new leadership in these institutions as well as in the Department of Finance should take a look at how they can address the governance and structural weaknesses in these institutions in a lasting manner.
Mr. Romeo Bernardo is managing director of Lazaro Bernardo Tiu & Associates, Inc. (a consultancy firm), board member of The Institute for Development and Econometric Analysis, Inc, and was undersecretary of Finance during the Aquino 1 and Ramos administrations.
Monday, July 26, 2010
Political economy of reform
Business World
Introspective
At a recent forum organized by the IMF-UP School of Economics- Philippine Economics Society, four speakers - one IMF economist, two UP professors (Philip Medalla and Ben Diokno) and I - were asked what we thought were needed to raise potential growth for the Philippines. This column is a shortened version of my remarks.
Basically, I think IMF Resident Representative Dennis Botman already summarized these solutions quite well. These include: a) raising the tax effort, b) increasing public investment, and c) reducing the cost of doing business by improving governance. I have little to add to what has already been said by most observers and would like to try to answer the corollary question, how to get it done politically, an important and difficult question to answer in a complex free-for-all democratic setting like the Philippines.
I offer some reflections based on a paper my colleague Christine Tang and I did on the subject of political economy of reform during the Ramos administration as part of a case study series for the Growth Commission of the World Bank. (The full report can be accessed at:
http://www.growthcommission.org/storage/cgdev/documents/gcwp039web.pdf).
We looked at what it took the Ramos administration to successfully push for reform in telecom de-monopolization, water privatization, and oil de-regulation working against strong special interests (including from affected businessmen, labor constituencies, political ideologues) and using instruments, both formal and informal, at the disposal of the presidency in an environment of weak, lethargic, or sometimes obstructive and compromised institutions.
Even though the three reform case studies were on specific initiatives done during the Ramos administration, the basic reform agenda was a continuation or, if you will, a fuller articulation and execution of the framework of stabilize, privatize and liberalize as a way to improve growth performance adopted during the time of President Cory Aquino (the Aquino 1 administration).
While the Aquino 1 government in 1986 had the advantage of having the Filipino people geared up for wide-scale political economic and social reforms, with the President clothed with full legislative powers early in her term, it also had to contend with the task of rebuilding democracy and its institutions after a 15-year dictatorship. This meant needing to have on her team people with sharply divided views on economic policy and, even more unfortunately, having to contend with seven coup attempts. This led them to score victories in some areas (e.g., tax reform, trade liberalization), duds in others (encouraging investments), and in one field a complete disaster (under-provision of power that led to two years of economic contraction).
The Ramos government, on the other hand, because of the President's background and an orderly succession that was the lasting legacy of the Aquino 1 administration, was not fettered by coup challenges, but rather the normal challenges that a presidency faces such as pushing for laws to a Congress where the President's party was not the majority.
In that respect, the setting that President Noynoy Aquino faces is more like that of a normal president. Additionally, he has an advantage that President Ramos did not enjoy - a more resounding electoral victory and an unprecedented trust rating of 88% - valuable political capital that needs to be used optimally. (One can wickedly observe, though, that as with most things, trust rating is not a question of size, but what one does with it.)
The lessons we took from the reform experience during those years can be stylized under the following headings: articulating a vision; scoring early success; political will; effective communication and constituency building; and opportunistic timing, pragmatism, judicious haste and persistence. I try to discuss each with the best intentions of sharing what I personally have learned.
1. Articulating a vision.
The Ramos administration's vision had been to pursue reforms that would create a Philippines 2000, which as my fellow Introspective columnist Toti Chikiamco characterized as a carefully crafted strategic vision that brought coherence to his government. Policies like 'leveling the playing field', dismantling monopolies, privatizing state assets and services, embracing liberalization and globalization, forging peace agreements with the MNLF and the rightists, etc, were adopted to make the country an Asian economic tiger, or at least a tiger cub.
We look forward to President Noynoy's State of the Nation Address that will mark his transformation from being just a 'reactionary' leader, elected on anti-Arroyo sentiments and admiration for his parents, into a visionary one.
2. Scoring early success
A new president has six years to make a difference and needs to score early wins to build confidence for future reform efforts.
During the Ramos administration, the immediate problem, and opportunity, was getting the economy on track after debilitating outages that saw the GDP contract by 0.6% - to put back the lights back on both literally and in terms of business confidence. This was achieved in a record of 15 months, thanks to Mr Ramos's no-nonsense leadership and empowerment of known achievers such as Energy Secretary Del Lazaro and NPC President Sonny Viray. Such a victory set the stage for reviving investments and rallying public support behind other reforms to improve global competitiveness.
There is no one thing as dramatic as putting the lights back on this time around, but it is clear that this administration is aware of the importance of early wins. Indeed, it has already scored well in terms of both signaling and getting the support of the people for regime change in two areas: a) ending the use of sirens by the powerful and as we say it coloquially the feeling powerful, and b) aggressive filing of charges against tax evaders starting with a Lamborghini-owning billionaire. (Though one has to question whether requiring market vendors and tricycle drivers to issue receipts make the cut for early success.)
Packaged with other meaningful actions that show determination in improved governance and in getting things done, these steps can restart the process of reversing the 10-year deterioration in international indicators of governance and transparency, global competitiveness, and ease of doing business as well as in our credit ratings which we have all lamented.
My candidates for demonstration of resolve and early success are topped by the following:
a). Getting the wasting NAIA Terminal 3 operational for international air traffic. This structure otherwise stands as an almost decade-old national monument to folly, corruption and, for failing to find a solution on how to use it, stupidity.
b). More train cars in MRT 3 and fewer buses along EDSA to decongest traffic. The economics or even just common sense of additional cars with little incremental costs for a system that is already in place is so compelling. The only possible reason that this has not been done in the past is the tainted procurement dispute among competing interests, perhaps a la ZTE. The excess of buses racing through EDSA like Formula One cars for scant passengers during non-rush hours has been linked to a surplus of franchises and to illegal operators rumored to be under the protection of generals.
c). Taking steps to scrap the NFA and stop financial hemorrhage. The NFA lost P37 billion in 2008 and P63 billion in 2009. According to a World Bank study, it cost the NFA an estimated average of P5 to deliver P1 subsidy to the poor, reflecting the wastes, leakages, and governance deficit in its administration. It does nothing for the poor farmers who especially at a time of high prices (like now) are deprived of the benefits of a remunerative price. Start by having leadership in DA and NFA that understand and can be committed to such a long overdue reform measure. This can also be matched by scaling up the conditional cash transfer program to gain greater public acceptability.
3. Political will
Reform requires a lot of political will on the part of the leader. For example, in the case of the telecom demonopolization, the situation in 1992 was perhaps best captured by a remark attributed to then PM Lee Kuan Yew - 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.
An estimated 800,000 applicants, 75% of the country's capital (Metro Manila), were then queuing for a telephone.
The PLDT, which owned the nationwide transmission backbone, was a virtual monopoly, controlling over 90% of the country's telephone lines. Its controlling shareholder, the Cojuangco family, was politically well connected, its influence extending across the three branches of government as well as media. According to a report by then Far Eastern Economic Review writer Bobbi Tiglao, If he loses this duel with the Cojuangco clan...the president's credibility as a strong leader will be severely dented.
Nevertheless, the Ramos administration proceeded to pry the sector open with various tactics. These ranged from encouraging the formation of consumer groups that took to the streets and clamoured for change, to boardroom battles where the President replaced government's representatives in the PLDT board, to behind-the-scenes manoeuvres to increase the concerned parties' receptiveness to reform.
As a result, twin executive orders that the President issued within six months of each other in 1993 (i.e., within one year of his assumption of office) opened the floodgates to investment in the sector. This was followed by pushing legislation to insulate the reform from reversal.
Similar demonstrations of political will were evident in the largest water privatization at that time, which required raising water rates prior to selling and reducing the MWSS work force, and in pursuing oil deregulation despite ideological opposition and a nullification of the first law by the Supreme Court.
In light of relative weaknesses of Philippine institutions, where the system of checks and balances put in place to stem abuses is often exploited by those opposing reform to block or at least delay it, carrying out the needed changes would have been very difficult if not impossible without the President's vision and strength of conviction.
Will the new administration have the political will to take on similar powerful interests that block the path to a globally competitive Philippines?
4. Effective communication and constituency building
This entailed establishing a Legislative Executive Development Advisory Council (LEDAC) where the executive met weekly with leaders of Congress, pacifying militant elements of society by granting amnesty to rebel soldiers, repealing the law that outlawed the Communist Party, and launching peace talks that led to the 1996 peace agreement with the MNLF.
This also included a penchant for summitry, which earlier annoyed me as a finance undersecretary since I sometimes found little by way of substantive output from them. That was my sentiment until I began to appreciate that the most important output at the end of the day was the process. It allowed stakeholders to participate in and understand what government had in mind and to buy into what government was trying to do.
5. The reform process - opportunistic timing, pragmatism, judicious haste, persistence
Compared to the resolution of the power crisis, the three reforms discussed may be considered elective surgery, i.e., mending a non-crisis situation. Therefore, they demonstrate better the reform process in a democratic setting where the leader himself has to generate the impetus for reform through his vision and persuasion and to craft the approaches that are politically feasible. The case studies show that the Ramos administration had to address the problems in each area in ways that were possible given the timing, the window of opportunity, conditions prevailing, and other prospects available.
These considerations are perhaps useful in weighing the timing for pushing tax policy reforms needed for fiscal sustainability, immunizing the economy from global financial turbulence, and generating needed resources for social and infrastructure spending.
I have argued that the best time to push for this is early in the administration - while the government is at the height of its trust and popularity rating and some of the responsibility for needed, possibly unpopular, reform measures can still be rightly laid at the doorstep of its predecessor, and where the new administration can earn credibility dividend from the financial markets that translates into front-loaded savings. One can argue that such an opportunistic approach was observed with the Ramos reforms.
While I can appreciate the reluctance to pass laws on new taxes, I cannot see why some of these measures cannot be pushed as refinements and broadening of the tax base to make it fairer or even as plugging the loopholes. I would easily put in this category the rationalization of fiscal incentives which leads to an even playing field in business.
One can even push the argument further that a retroactive indexation of sin taxes, say, on liquor and tobacco, does not mean new taxes but simply a restoration of the real value of taxes eroded by inflation (even if these two items will not really yield much, tax adjustments are clearly called for on health grounds).
Sooner or later, government should also push for correcting the relative under-taxation of oil products, a more robust progressive source by far, either as a stand-alone or with proceeds earmarked for spending to ease public acceptance.
The best timing for pushing such an increase in oil taxes measures and other difficult measures like an increase in VAT coupled with or without a reduction in income taxes is a political call the leader and his economic managers and Congress team will need to make. Waiting too long to do tax policy reform and relying only on administrative measures, however, runs the risk of having a fiscal crisis dictate non-elective surgery. Or if we are not too unlucky, muddling through several more years of unremarkable economic performance.
Mr. Romeo Bernardo is board member of The Institute for Development and Econometric Analysis, Inc., and a GlobalSource partners advisor. He was formerly undersecretary of Finance during the Aquino1 and Ramos administrations.
Introspective
At a recent forum organized by the IMF-UP School of Economics- Philippine Economics Society, four speakers - one IMF economist, two UP professors (Philip Medalla and Ben Diokno) and I - were asked what we thought were needed to raise potential growth for the Philippines. This column is a shortened version of my remarks.
Basically, I think IMF Resident Representative Dennis Botman already summarized these solutions quite well. These include: a) raising the tax effort, b) increasing public investment, and c) reducing the cost of doing business by improving governance. I have little to add to what has already been said by most observers and would like to try to answer the corollary question, how to get it done politically, an important and difficult question to answer in a complex free-for-all democratic setting like the Philippines.
I offer some reflections based on a paper my colleague Christine Tang and I did on the subject of political economy of reform during the Ramos administration as part of a case study series for the Growth Commission of the World Bank. (The full report can be accessed at:
http://www.growthcommission.org/storage/cgdev/documents/gcwp039web.pdf).
We looked at what it took the Ramos administration to successfully push for reform in telecom de-monopolization, water privatization, and oil de-regulation working against strong special interests (including from affected businessmen, labor constituencies, political ideologues) and using instruments, both formal and informal, at the disposal of the presidency in an environment of weak, lethargic, or sometimes obstructive and compromised institutions.
Even though the three reform case studies were on specific initiatives done during the Ramos administration, the basic reform agenda was a continuation or, if you will, a fuller articulation and execution of the framework of stabilize, privatize and liberalize as a way to improve growth performance adopted during the time of President Cory Aquino (the Aquino 1 administration).
While the Aquino 1 government in 1986 had the advantage of having the Filipino people geared up for wide-scale political economic and social reforms, with the President clothed with full legislative powers early in her term, it also had to contend with the task of rebuilding democracy and its institutions after a 15-year dictatorship. This meant needing to have on her team people with sharply divided views on economic policy and, even more unfortunately, having to contend with seven coup attempts. This led them to score victories in some areas (e.g., tax reform, trade liberalization), duds in others (encouraging investments), and in one field a complete disaster (under-provision of power that led to two years of economic contraction).
The Ramos government, on the other hand, because of the President's background and an orderly succession that was the lasting legacy of the Aquino 1 administration, was not fettered by coup challenges, but rather the normal challenges that a presidency faces such as pushing for laws to a Congress where the President's party was not the majority.
In that respect, the setting that President Noynoy Aquino faces is more like that of a normal president. Additionally, he has an advantage that President Ramos did not enjoy - a more resounding electoral victory and an unprecedented trust rating of 88% - valuable political capital that needs to be used optimally. (One can wickedly observe, though, that as with most things, trust rating is not a question of size, but what one does with it.)
The lessons we took from the reform experience during those years can be stylized under the following headings: articulating a vision; scoring early success; political will; effective communication and constituency building; and opportunistic timing, pragmatism, judicious haste and persistence. I try to discuss each with the best intentions of sharing what I personally have learned.
1. Articulating a vision.
The Ramos administration's vision had been to pursue reforms that would create a Philippines 2000, which as my fellow Introspective columnist Toti Chikiamco characterized as a carefully crafted strategic vision that brought coherence to his government. Policies like 'leveling the playing field', dismantling monopolies, privatizing state assets and services, embracing liberalization and globalization, forging peace agreements with the MNLF and the rightists, etc, were adopted to make the country an Asian economic tiger, or at least a tiger cub.
We look forward to President Noynoy's State of the Nation Address that will mark his transformation from being just a 'reactionary' leader, elected on anti-Arroyo sentiments and admiration for his parents, into a visionary one.
2. Scoring early success
A new president has six years to make a difference and needs to score early wins to build confidence for future reform efforts.
During the Ramos administration, the immediate problem, and opportunity, was getting the economy on track after debilitating outages that saw the GDP contract by 0.6% - to put back the lights back on both literally and in terms of business confidence. This was achieved in a record of 15 months, thanks to Mr Ramos's no-nonsense leadership and empowerment of known achievers such as Energy Secretary Del Lazaro and NPC President Sonny Viray. Such a victory set the stage for reviving investments and rallying public support behind other reforms to improve global competitiveness.
There is no one thing as dramatic as putting the lights back on this time around, but it is clear that this administration is aware of the importance of early wins. Indeed, it has already scored well in terms of both signaling and getting the support of the people for regime change in two areas: a) ending the use of sirens by the powerful and as we say it coloquially the feeling powerful, and b) aggressive filing of charges against tax evaders starting with a Lamborghini-owning billionaire. (Though one has to question whether requiring market vendors and tricycle drivers to issue receipts make the cut for early success.)
Packaged with other meaningful actions that show determination in improved governance and in getting things done, these steps can restart the process of reversing the 10-year deterioration in international indicators of governance and transparency, global competitiveness, and ease of doing business as well as in our credit ratings which we have all lamented.
My candidates for demonstration of resolve and early success are topped by the following:
a). Getting the wasting NAIA Terminal 3 operational for international air traffic. This structure otherwise stands as an almost decade-old national monument to folly, corruption and, for failing to find a solution on how to use it, stupidity.
b). More train cars in MRT 3 and fewer buses along EDSA to decongest traffic. The economics or even just common sense of additional cars with little incremental costs for a system that is already in place is so compelling. The only possible reason that this has not been done in the past is the tainted procurement dispute among competing interests, perhaps a la ZTE. The excess of buses racing through EDSA like Formula One cars for scant passengers during non-rush hours has been linked to a surplus of franchises and to illegal operators rumored to be under the protection of generals.
c). Taking steps to scrap the NFA and stop financial hemorrhage. The NFA lost P37 billion in 2008 and P63 billion in 2009. According to a World Bank study, it cost the NFA an estimated average of P5 to deliver P1 subsidy to the poor, reflecting the wastes, leakages, and governance deficit in its administration. It does nothing for the poor farmers who especially at a time of high prices (like now) are deprived of the benefits of a remunerative price. Start by having leadership in DA and NFA that understand and can be committed to such a long overdue reform measure. This can also be matched by scaling up the conditional cash transfer program to gain greater public acceptability.
3. Political will
Reform requires a lot of political will on the part of the leader. For example, in the case of the telecom demonopolization, the situation in 1992 was perhaps best captured by a remark attributed to then PM Lee Kuan Yew - 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.
An estimated 800,000 applicants, 75% of the country's capital (Metro Manila), were then queuing for a telephone.
The PLDT, which owned the nationwide transmission backbone, was a virtual monopoly, controlling over 90% of the country's telephone lines. Its controlling shareholder, the Cojuangco family, was politically well connected, its influence extending across the three branches of government as well as media. According to a report by then Far Eastern Economic Review writer Bobbi Tiglao, If he loses this duel with the Cojuangco clan...the president's credibility as a strong leader will be severely dented.
Nevertheless, the Ramos administration proceeded to pry the sector open with various tactics. These ranged from encouraging the formation of consumer groups that took to the streets and clamoured for change, to boardroom battles where the President replaced government's representatives in the PLDT board, to behind-the-scenes manoeuvres to increase the concerned parties' receptiveness to reform.
As a result, twin executive orders that the President issued within six months of each other in 1993 (i.e., within one year of his assumption of office) opened the floodgates to investment in the sector. This was followed by pushing legislation to insulate the reform from reversal.
Similar demonstrations of political will were evident in the largest water privatization at that time, which required raising water rates prior to selling and reducing the MWSS work force, and in pursuing oil deregulation despite ideological opposition and a nullification of the first law by the Supreme Court.
In light of relative weaknesses of Philippine institutions, where the system of checks and balances put in place to stem abuses is often exploited by those opposing reform to block or at least delay it, carrying out the needed changes would have been very difficult if not impossible without the President's vision and strength of conviction.
Will the new administration have the political will to take on similar powerful interests that block the path to a globally competitive Philippines?
4. Effective communication and constituency building
This entailed establishing a Legislative Executive Development Advisory Council (LEDAC) where the executive met weekly with leaders of Congress, pacifying militant elements of society by granting amnesty to rebel soldiers, repealing the law that outlawed the Communist Party, and launching peace talks that led to the 1996 peace agreement with the MNLF.
This also included a penchant for summitry, which earlier annoyed me as a finance undersecretary since I sometimes found little by way of substantive output from them. That was my sentiment until I began to appreciate that the most important output at the end of the day was the process. It allowed stakeholders to participate in and understand what government had in mind and to buy into what government was trying to do.
5. The reform process - opportunistic timing, pragmatism, judicious haste, persistence
Compared to the resolution of the power crisis, the three reforms discussed may be considered elective surgery, i.e., mending a non-crisis situation. Therefore, they demonstrate better the reform process in a democratic setting where the leader himself has to generate the impetus for reform through his vision and persuasion and to craft the approaches that are politically feasible. The case studies show that the Ramos administration had to address the problems in each area in ways that were possible given the timing, the window of opportunity, conditions prevailing, and other prospects available.
These considerations are perhaps useful in weighing the timing for pushing tax policy reforms needed for fiscal sustainability, immunizing the economy from global financial turbulence, and generating needed resources for social and infrastructure spending.
I have argued that the best time to push for this is early in the administration - while the government is at the height of its trust and popularity rating and some of the responsibility for needed, possibly unpopular, reform measures can still be rightly laid at the doorstep of its predecessor, and where the new administration can earn credibility dividend from the financial markets that translates into front-loaded savings. One can argue that such an opportunistic approach was observed with the Ramos reforms.
While I can appreciate the reluctance to pass laws on new taxes, I cannot see why some of these measures cannot be pushed as refinements and broadening of the tax base to make it fairer or even as plugging the loopholes. I would easily put in this category the rationalization of fiscal incentives which leads to an even playing field in business.
One can even push the argument further that a retroactive indexation of sin taxes, say, on liquor and tobacco, does not mean new taxes but simply a restoration of the real value of taxes eroded by inflation (even if these two items will not really yield much, tax adjustments are clearly called for on health grounds).
Sooner or later, government should also push for correcting the relative under-taxation of oil products, a more robust progressive source by far, either as a stand-alone or with proceeds earmarked for spending to ease public acceptance.
The best timing for pushing such an increase in oil taxes measures and other difficult measures like an increase in VAT coupled with or without a reduction in income taxes is a political call the leader and his economic managers and Congress team will need to make. Waiting too long to do tax policy reform and relying only on administrative measures, however, runs the risk of having a fiscal crisis dictate non-elective surgery. Or if we are not too unlucky, muddling through several more years of unremarkable economic performance.
Mr. Romeo Bernardo is board member of The Institute for Development and Econometric Analysis, Inc., and a GlobalSource partners advisor. He was formerly undersecretary of Finance during the Aquino1 and Ramos administrations.
Monday, June 28, 2010
Tax policy reform - it's time
Business World
Introspective
In an earlier column, Fiscal imperative for the next administration (Oct. 5, 2009), I wrote on why there is compelling need for the next administration to plug leakages in tax collection and push for tax policy reform early in its term. The imperative is driven by structural erosion in revenues from non-indexation of excise taxes to inflation over the past decade, from legislated tax breaks more recently, and from newly legislated salary and pension adjustments over the next three years. Behind it also is a desperate need for spending on catch-up infrastructure and social services which had been held back by weak revenues in the past.
Having recently attended a tax policy forum with representatives of multilateral institutions, government officials (current and past), academics, representatives of business organizations and civil society members as participants, I am more convinced than ever that somehow the new administration will need to lead the nation to accept adjustments in some taxes. The sooner, the better.
Presentations at the forum showed how miserably we underperformed in key social indicators such as health and education compared to our peers - Indonesia, Malaysia, Thailand, and Vietnam - with our rankings dropping steadily over time and consistently landing near or at the bottom. This comes as no surprise since government has been consistently underspending compared to these countries especially in the last decade. This is true as well for capital outlays where our annual spending is a mere 3% of GDP compared to an average of twice that for these countries. Quite obviously, our expenditure trends largely follow declining revenues.
President-elect Noynoy Aquino has said that before he would support tax increases, his government would first try to fix the leaky tax bucket. His finance secretary designate and prospective heads of the internal revenue and customs bureaus as reported by the media are well-known and highly regarded professionals with strong track records and hence well placed to do just that. But can reforms in the tax system wait?
Finance Undersecretary Gil Beltran makes a good case for doing it sooner rather than later. He said tax breaks given by the last Congress already exceeds P100 billion in total, or about 1.2% of GDP. Add to this the legislated increases in wages and pensions set to take effect over the next three years estimated at P125 billion, or 1.6% of GDP. These two elements alone equal roughly 3% of GDP. The projected national government deficit for 2010, which is deemed unsustainable by many, is already at 3.6% of GDP.
How much can administrative reform under the best tax authorities with the full backing of a determined President who has strong public mandate for governance reform yield over the short term? Undersecretary Beltran said that improved tax administration yielded the equivalent of just 0.6% of GDP during the administration of President Cory Aquino and only 0.5% during the term of President Fidel Ramos. Judging from international experience validated by former heads of internal revenue agencies of Chile and Guatemala who gave presentations at the forum, an improvement in revenue collection equivalent to 1% of GDP over a one-year period would already be a feat.
I am prepared to grant that incoming fiscal authorities can set such a record on this. In part because of my knowledge of and regard for the named collectors and in part because of well-known low-lying fruit, including wholesale oil smuggling euphemistically referred to by the IMF in a 2008 report as undervaluation of imports due to election-related lenience (which GlobalSource estimated at around P20 billion in 2007).
But where will the additional revenues needed come from? Policy analysts, including this one, have pushed for two measures:
a) Adjustment in excise taxes whose value has been eroded over time to the tune of 1.8% of GDP.
b) Rationalization of redundant fiscal incentives costing the government 1% of GDP annually.
Bulk of the erosion in value on excise taxes has been on petroleum, rather than on tobacco and alcohol, so most of the revenue yield can be obtained from this. As many studies have shown, including most recently by the World Bank (World Bank Philippines Quarterly Update: Laying Out the Exit Strategies), oil taxes are progressive, i.e., the rich pay proportionately more, while our oil taxes are among the lowest in the world even compared to our peers. There are in addition social costs to burning fuel particularly for the environment that are not reflected in price. The case for upward adjustments in tobacco and alcohol, on the other hand, rests more on health reasons than revenue generation, as demand for these products is elastic and may not necessarily lead to a substantial increase in government tax take.
The scholarly case for rationalizing incentives, especially scrapping the redundant ones, has already been laid out well in a study by Philip Medalla and Renato Reside of the UP School of Economics. They argue not only on revenue grounds but also for levelling the playing field. This almost passed in Congress under the lead of Senator Ralph Recto. Resuscitating it should not be too difficult.
One can easily take the position that these reforms can wait until government plugs tax leakages. But such a stance means lost time in raising tax effort to a level at par with similarly-rated peers, spurring development, and bringing the country to a higher growth path. It makes the country more vulnerable to financial market sentiment that is becoming less forgiving of growing fiscal deficits and debt ratios (as seen in the case of Greece and other crisis countries in the euro zone) especially as the world exits recession and begins to reverse from a fiscal stimulus mode. Moreover, it potentially wastes the good political capital of a new administration blessed with a strong popular mandate. Based on past experience, such political potency erodes through the years if not just months.
Mr. Romeo Bernardo is board member of The Institute for Development and Econometric Analysis, Inc., managing director of Lazaro Bernardo Tiu & Associates, Inc., and a GlobalSource partners advisor. He was formerly undersecretary of Finance during the Aquino and Ramos administrations.
Introspective
In an earlier column, Fiscal imperative for the next administration (Oct. 5, 2009), I wrote on why there is compelling need for the next administration to plug leakages in tax collection and push for tax policy reform early in its term. The imperative is driven by structural erosion in revenues from non-indexation of excise taxes to inflation over the past decade, from legislated tax breaks more recently, and from newly legislated salary and pension adjustments over the next three years. Behind it also is a desperate need for spending on catch-up infrastructure and social services which had been held back by weak revenues in the past.
Presentations at the forum showed how miserably we underperformed in key social indicators such as health and education compared to our peers - Indonesia, Malaysia, Thailand, and Vietnam - with our rankings dropping steadily over time and consistently landing near or at the bottom. This comes as no surprise since government has been consistently underspending compared to these countries especially in the last decade. This is true as well for capital outlays where our annual spending is a mere 3% of GDP compared to an average of twice that for these countries. Quite obviously, our expenditure trends largely follow declining revenues.
President-elect Noynoy Aquino has said that before he would support tax increases, his government would first try to fix the leaky tax bucket. His finance secretary designate and prospective heads of the internal revenue and customs bureaus as reported by the media are well-known and highly regarded professionals with strong track records and hence well placed to do just that. But can reforms in the tax system wait?
Finance Undersecretary Gil Beltran makes a good case for doing it sooner rather than later. He said tax breaks given by the last Congress already exceeds P100 billion in total, or about 1.2% of GDP. Add to this the legislated increases in wages and pensions set to take effect over the next three years estimated at P125 billion, or 1.6% of GDP. These two elements alone equal roughly 3% of GDP. The projected national government deficit for 2010, which is deemed unsustainable by many, is already at 3.6% of GDP.
How much can administrative reform under the best tax authorities with the full backing of a determined President who has strong public mandate for governance reform yield over the short term? Undersecretary Beltran said that improved tax administration yielded the equivalent of just 0.6% of GDP during the administration of President Cory Aquino and only 0.5% during the term of President Fidel Ramos. Judging from international experience validated by former heads of internal revenue agencies of Chile and Guatemala who gave presentations at the forum, an improvement in revenue collection equivalent to 1% of GDP over a one-year period would already be a feat.
I am prepared to grant that incoming fiscal authorities can set such a record on this. In part because of my knowledge of and regard for the named collectors and in part because of well-known low-lying fruit, including wholesale oil smuggling euphemistically referred to by the IMF in a 2008 report as undervaluation of imports due to election-related lenience (which GlobalSource estimated at around P20 billion in 2007).
But where will the additional revenues needed come from? Policy analysts, including this one, have pushed for two measures:
a) Adjustment in excise taxes whose value has been eroded over time to the tune of 1.8% of GDP.
b) Rationalization of redundant fiscal incentives costing the government 1% of GDP annually.
Bulk of the erosion in value on excise taxes has been on petroleum, rather than on tobacco and alcohol, so most of the revenue yield can be obtained from this. As many studies have shown, including most recently by the World Bank (World Bank Philippines Quarterly Update: Laying Out the Exit Strategies), oil taxes are progressive, i.e., the rich pay proportionately more, while our oil taxes are among the lowest in the world even compared to our peers. There are in addition social costs to burning fuel particularly for the environment that are not reflected in price. The case for upward adjustments in tobacco and alcohol, on the other hand, rests more on health reasons than revenue generation, as demand for these products is elastic and may not necessarily lead to a substantial increase in government tax take.
The scholarly case for rationalizing incentives, especially scrapping the redundant ones, has already been laid out well in a study by Philip Medalla and Renato Reside of the UP School of Economics. They argue not only on revenue grounds but also for levelling the playing field. This almost passed in Congress under the lead of Senator Ralph Recto. Resuscitating it should not be too difficult.
One can easily take the position that these reforms can wait until government plugs tax leakages. But such a stance means lost time in raising tax effort to a level at par with similarly-rated peers, spurring development, and bringing the country to a higher growth path. It makes the country more vulnerable to financial market sentiment that is becoming less forgiving of growing fiscal deficits and debt ratios (as seen in the case of Greece and other crisis countries in the euro zone) especially as the world exits recession and begins to reverse from a fiscal stimulus mode. Moreover, it potentially wastes the good political capital of a new administration blessed with a strong popular mandate. Based on past experience, such political potency erodes through the years if not just months.
Mr. Romeo Bernardo is board member of The Institute for Development and Econometric Analysis, Inc., managing director of Lazaro Bernardo Tiu & Associates, Inc., and a GlobalSource partners advisor. He was formerly undersecretary of Finance during the Aquino and Ramos administrations.
Tax policy reform - it's time
Business World
Introspective
In an earlier column, Fiscal imperative for the next administration (Oct. 5, 2009), I wrote on why there is compelling need for the next administration to plug leakages in tax collection and push for tax policy reform early in its term. The imperative is driven by structural erosion in revenues from non-indexation of excise taxes to inflation over the past decade, from legislated tax breaks more recently, and from newly legislated salary and pension adjustments over the next three years. Behind it also is a desperate need for spending on catch-up infrastructure and social services which had been held back by weak revenues in the past.
Having recently attended a tax policy forum with representatives of multilateral institutions, government officials (current and past), academics, representatives of business organizations and civil society members as participants, I am more convinced than ever that somehow the new administration will need to lead the nation to accept adjustments in some taxes. The sooner, the better.
Presentations at the forum showed how miserably we underperformed in key social indicators such as health and education compared to our peers - Indonesia, Malaysia, Thailand, and Vietnam - with our rankings dropping steadily over time and consistently landing near or at the bottom. This comes as no surprise since government has been consistently underspending compared to these countries especially in the last decade. This is true as well for capital outlays where our annual spending is a mere 3% of GDP compared to an average of twice that for these countries. Quite obviously, our expenditure trends largely follow declining revenues.
President-elect Noynoy Aquino has said that before he would support tax increases, his government would first try to fix the leaky tax bucket. His finance secretary designate and prospective heads of the internal revenue and customs bureaus as reported by the media are well-known and highly regarded professionals with strong track records and hence well placed to do just that. But can reforms in the tax system wait?
Finance Undersecretary Gil Beltran makes a good case for doing it sooner rather than later. He said tax breaks given by the last Congress already exceeds P100 billion in total, or about 1.2% of GDP. Add to this the legislated increases in wages and pensions set to take effect over the next three years estimated at P125 billion, or 1.6% of GDP. These two elements alone equal roughly 3% of GDP. The projected national government deficit for 2010, which is deemed unsustainable by many, is already at 3.6% of GDP.
How much can administrative reform under the best tax authorities with the full backing of a determined President who has strong public mandate for governance reform yield over the short term? Undersecretary Beltran said that improved tax administration yielded the equivalent of just 0.6% of GDP during the administration of President Cory Aquino and only 0.5% during the term of President Fidel Ramos. Judging from international experience validated by former heads of internal revenue agencies of Chile and Guatemala who gave presentations at the forum, an improvement in revenue collection equivalent to 1% of GDP over a one-year period would already be a feat.
I am prepared to grant that incoming fiscal authorities can set such a record on this. In part because of my knowledge of and regard for the named collectors and in part because of well-known low-lying fruit, including wholesale oil smuggling euphemistically referred to by the IMF in a 2008 report as undervaluation of imports due to election-related lenience (which GlobalSource estimated at around P20 billion in 2007).
But where will the additional revenues needed come from? Policy analysts, including this one, have pushed for two measures:
a) Adjustment in excise taxes whose value has been eroded over time to the tune of 1.8% of GDP.
b) Rationalization of redundant fiscal incentives costing the government 1% of GDP annually.
Bulk of the erosion in value on excise taxes has been on petroleum, rather than on tobacco and alcohol, so most of the revenue yield can be obtained from this. As many studies have shown, including most recently by the World Bank (World Bank Philippines Quarterly Update: Laying Out the Exit Strategies), oil taxes are progressive, i.e., the rich pay proportionately more, while our oil taxes are among the lowest in the world even compared to our peers. There are in addition social costs to burning fuel particularly for the environment that are not reflected in price. The case for upward adjustments in tobacco and alcohol, on the other hand, rests more on health reasons than revenue generation, as demand for these products is elastic and may not necessarily lead to a substantial increase in government tax take.
The scholarly case for rationalizing incentives, especially scrapping the redundant ones, has already been laid out well in a study by Philip Medalla and Renato Reside of the UP School of Economics. They argue not only on revenue grounds but also for leveling the playing field. This almost passed in Congress under the lead of Senator Ralph Recto. Resuscitating it should not be too difficult.
One can easily take the position that these reforms can wait until government plugs tax leakages. But such a stance means lost time in raising tax effort to a level at par with similarly-rated peers, spurring development, and bringing the country to a higher growth path. It makes the country more vulnerable to financial market sentiment that is becoming less forgiving of growing fiscal deficits and debt ratios (as seen in the case of Greece and other crisis countries in the euro zone) especially as the world exits recession and begins to reverse from a fiscal stimulus mode. Moreover, it potentially wastes the good political capital of a new administration blessed with a strong popular mandate. Based on past experience, such political potency erodes through the years if not just months.
Mr. Romeo Bernardo is board member of The Institute for Development and Econometric Analysis, Inc., managing director of Lazaro Bernardo Tiu & Associates, Inc., and a GlobalSource partners advisor. He was formerly undersecretary of Finance during the Aquino and Ramos administrations.
Introspective
In an earlier column, Fiscal imperative for the next administration (Oct. 5, 2009), I wrote on why there is compelling need for the next administration to plug leakages in tax collection and push for tax policy reform early in its term. The imperative is driven by structural erosion in revenues from non-indexation of excise taxes to inflation over the past decade, from legislated tax breaks more recently, and from newly legislated salary and pension adjustments over the next three years. Behind it also is a desperate need for spending on catch-up infrastructure and social services which had been held back by weak revenues in the past.
Having recently attended a tax policy forum with representatives of multilateral institutions, government officials (current and past), academics, representatives of business organizations and civil society members as participants, I am more convinced than ever that somehow the new administration will need to lead the nation to accept adjustments in some taxes. The sooner, the better.
Presentations at the forum showed how miserably we underperformed in key social indicators such as health and education compared to our peers - Indonesia, Malaysia, Thailand, and Vietnam - with our rankings dropping steadily over time and consistently landing near or at the bottom. This comes as no surprise since government has been consistently underspending compared to these countries especially in the last decade. This is true as well for capital outlays where our annual spending is a mere 3% of GDP compared to an average of twice that for these countries. Quite obviously, our expenditure trends largely follow declining revenues.
President-elect Noynoy Aquino has said that before he would support tax increases, his government would first try to fix the leaky tax bucket. His finance secretary designate and prospective heads of the internal revenue and customs bureaus as reported by the media are well-known and highly regarded professionals with strong track records and hence well placed to do just that. But can reforms in the tax system wait?
Finance Undersecretary Gil Beltran makes a good case for doing it sooner rather than later. He said tax breaks given by the last Congress already exceeds P100 billion in total, or about 1.2% of GDP. Add to this the legislated increases in wages and pensions set to take effect over the next three years estimated at P125 billion, or 1.6% of GDP. These two elements alone equal roughly 3% of GDP. The projected national government deficit for 2010, which is deemed unsustainable by many, is already at 3.6% of GDP.
How much can administrative reform under the best tax authorities with the full backing of a determined President who has strong public mandate for governance reform yield over the short term? Undersecretary Beltran said that improved tax administration yielded the equivalent of just 0.6% of GDP during the administration of President Cory Aquino and only 0.5% during the term of President Fidel Ramos. Judging from international experience validated by former heads of internal revenue agencies of Chile and Guatemala who gave presentations at the forum, an improvement in revenue collection equivalent to 1% of GDP over a one-year period would already be a feat.
I am prepared to grant that incoming fiscal authorities can set such a record on this. In part because of my knowledge of and regard for the named collectors and in part because of well-known low-lying fruit, including wholesale oil smuggling euphemistically referred to by the IMF in a 2008 report as undervaluation of imports due to election-related lenience (which GlobalSource estimated at around P20 billion in 2007).
But where will the additional revenues needed come from? Policy analysts, including this one, have pushed for two measures:
a) Adjustment in excise taxes whose value has been eroded over time to the tune of 1.8% of GDP.
b) Rationalization of redundant fiscal incentives costing the government 1% of GDP annually.
Bulk of the erosion in value on excise taxes has been on petroleum, rather than on tobacco and alcohol, so most of the revenue yield can be obtained from this. As many studies have shown, including most recently by the World Bank (World Bank Philippines Quarterly Update: Laying Out the Exit Strategies), oil taxes are progressive, i.e., the rich pay proportionately more, while our oil taxes are among the lowest in the world even compared to our peers. There are in addition social costs to burning fuel particularly for the environment that are not reflected in price. The case for upward adjustments in tobacco and alcohol, on the other hand, rests more on health reasons than revenue generation, as demand for these products is elastic and may not necessarily lead to a substantial increase in government tax take.
The scholarly case for rationalizing incentives, especially scrapping the redundant ones, has already been laid out well in a study by Philip Medalla and Renato Reside of the UP School of Economics. They argue not only on revenue grounds but also for leveling the playing field. This almost passed in Congress under the lead of Senator Ralph Recto. Resuscitating it should not be too difficult.
One can easily take the position that these reforms can wait until government plugs tax leakages. But such a stance means lost time in raising tax effort to a level at par with similarly-rated peers, spurring development, and bringing the country to a higher growth path. It makes the country more vulnerable to financial market sentiment that is becoming less forgiving of growing fiscal deficits and debt ratios (as seen in the case of Greece and other crisis countries in the euro zone) especially as the world exits recession and begins to reverse from a fiscal stimulus mode. Moreover, it potentially wastes the good political capital of a new administration blessed with a strong popular mandate. Based on past experience, such political potency erodes through the years if not just months.
Mr. Romeo Bernardo is board member of The Institute for Development and Econometric Analysis, Inc., managing director of Lazaro Bernardo Tiu & Associates, Inc., and a GlobalSource partners advisor. He was formerly undersecretary of Finance during the Aquino and Ramos administrations.
Wednesday, May 12, 2010
Investors await policies, action on RP's problems
Business World
A relatively smooth elections and the speedy release of results may have improved the market's view of the Philippines but actual investments will depend on the new administration's policy agenda, economists yesterday said.
Romeo L. Bernardo, a former Finance Undersecretary, said the outcome of Monday's exercise had put to rest market concerns of a failure of elections.
The election went smoother than expected. It seems the leading candidate has a clear mandate and we will not have dispute of proclamation, he said.
This removes the lack of certainty on succession.
But in the long term, said Mr. Bernardo, investors will be waiting for the composition of the new economic team and how the administration approaches problems such as the deficit and corruption.
Investors will want to see how cohesive his team will be in addressing these problems, he said.
HSBC economist Frederic Neumann, meanwhile, said investors would be taking a second look at the Philippines once a clear winner had been declared.
Despite worries, it went reasonably well, he said. Investors are going to be relieved that there is a clear winner, that there is certainty.
Citibank economist Francisco G. Trinidad, Jr. said that while the speedy count had bolstered the view of a credible elections, what is more important for the market is how the new administration sets the tone for policies.
Recent political developments have dispelled much of uncertainty prior to the elections but it will take familiarity with the new administration's policy agenda before we can ascertain the likelihood of the investment climate improving materially, he said.
Mr. Trinidad said investors would want the new administration to work on its fiscal position by improving tax administration and coming up with revenue measures.
[The] revenue side will be crucial to provide more cash flows to support anti-poverty programs and job creation, he said.
The government expects the deficit to hit P293 billion this year after reaching a record P298.5 billion in 2009.
As of the first quarter, the shortfall stood at P134.2 billion, higher than the programmed P110.9 billion due to higher expenditures and lackluster revenues.
Tuesday, May 4, 2010
Economic issues for next president
Business World
Introspective
The author moderated the discussion by a panel of economists in the 9th Ayala Corporation-UP School of Economics Lecture Series last April 14. The panel was composed of former Economic Planning Secretary Philip Medalla, former Budget Secretary Benjamin Diokno, former Agriculture Undersecretary Arsi Balisacan, and Raul Fabella, former dean of the UP School of Economics. Below is the continuation of the author's introductory remarks intended to frame the discussion:
B. Fiscal: How to generate resources needed for infra and social spending and to enhance private investment climate through sound macro.
1. Introduction: The new government will be coming in with debt to GDP levels quite high (57% vs. 35 to 45% for our neighbors), tax-to-GDP ratio close to historic lows (at 12. 7% vs. 15 to 16% for the region), erosion in revenues due to new measures passed over the last couple of years and for specific taxes, from inflation. At the same time it needs resources to address the large infrastructure and social spending deficit/backlog that is creating a drag on the country's future growth which can only get worse with time. Our infra spending is only about half the average for the region of 5% of GDP, and our education quality has slipped dismally over the years, and from being one of the highest among our peers, is now down the cellar.
2. Questions:
a. How much can the next administration depend on improving tax administration/plugging leakages to generating fiscal resources? How can this new administration generate sizeable increases in collection via improved administration considering poor track record of past administrations (and modest successes in other countries that yielded no more than 1% of GDP)?
b. Should the new administration look to new/additional taxes? VAT, excise taxes, especially on oil, text tax? How to generate public support for new taxes?
c. What reforms are needed in spending priorities to get more bang for the taxpayer buck? In budget and procurement processes?
C. Government Interventions in Imperfect and/or Important Markets. How should government intervene better in key sectors to generate inclusive sustainable growth?
1. Introduction: There are a number of key areas where there is serious lack of supply, despite clear demand, perhaps bordering on crisis proportions if unattended. Examples are in important infrastructure like power, water, and mass transport. Just to illustrate how market or government failure can lead to serious losses - consider the power crisis of 1991/92, resulting from failure to anticipate and build power plants and losses in growth and investment. Growths during those years were negative and only marginally positive, respectively, instead of what could have been at least the historic level of 4%. Even if we assume that the losses were confined only to those two years, putting aside losses from the fruits of lost investment and reputation damage, every 1% of growth forgone each year translates to P70 billion, $1.5 billion, the same price of as two Bataan Nuclear Power plants. Multiply this by 8 for the two years- that's what it cost the economy- that's P560 billion down a dark pit, lost forever. Presented this way, the losses of inaction for under provision of other important infrastructure - water, roads, mass transport, though perhaps not as staggering can be quite compelling.
2. Questions:
a. We are already seeing an increase in frequency and duration of power outages, perhaps driven by combination of factors - weather, inadequate reserves, breakdowns - what can the next administration do to prevent power crisis of the magnitude of the early '90s which is consistent with the EPIRA architecture and law? Or does the EPIRA need change?
b. In the other areas of water, mass transport, roads, how can government improve the investment climate for more public-private partnerships to augment its constrained budget for public works? Does the Philippines also need broader competition policy so that infra services become cheaper, for example in transport or power?
c. Is there a role for government providing fiscal incentives or production subsidies for particular industries or activities (say, SME financing, R and D, training) on a temporary basis until they can be competitive? What are the pitfalls to this strategy advocated by some?
D. Poverty Reduction: How can government make growth more inclusive?
1. Introduction: The Philippines now has one of the highest incidences of poverty counting over 20% of its population as having incomes below one dollar per day, higher than Vietnam, Indonesia, China. This is explained by limited dynamism of economic growth, which moreover has not translated to poverty reduction. There is likewise evidence of deterioration in the distribution of income. Factors identified by the World Bank as contributing to this deterioration include unequal, inadequate access to social services and social protection, leading to unequal sectoral and regional distribution of growth and barriers to factor mobility.
2. Questions:
a. What are the roots of poverty in the Philippines?
b. How might some of the barriers in factor mobility help reduce poverty, i.e., policy bias like legislated wages against low-skill employment, or biases vs. more efficient use of land due to agrarian reform? Too sensitive to embark on? Are there political feasible actions possible in these areas?
c. What improvements in social services and social protection are feasible, e.g., redeployment of NFA subsidies toward conditional cash transfers? What could be the possible political road map for doing this without raising obstacles on ground of food security, etc?
d. What are the other kinds of interventions should government embark in the areas of education and health, including reproductive health, that addresses the requirements of the poor that are politically feasible early on?
Mr. Romeo Bernardo is board member of The Institute for Development and Econometric Analysis, Inc. and managing director of Lazaro Bernardo Tiu & Associates, Inc. He was formerly undersecretary of Finance during the Aquino and Ramos administrations.
Introspective
The author moderated the discussion by a panel of economists in the 9th Ayala Corporation-UP School of Economics Lecture Series last April 14. The panel was composed of former Economic Planning Secretary Philip Medalla, former Budget Secretary Benjamin Diokno, former Agriculture Undersecretary Arsi Balisacan, and Raul Fabella, former dean of the UP School of Economics. Below is the continuation of the author's introductory remarks intended to frame the discussion:
B. Fiscal: How to generate resources needed for infra and social spending and to enhance private investment climate through sound macro.
1. Introduction: The new government will be coming in with debt to GDP levels quite high (57% vs. 35 to 45% for our neighbors), tax-to-GDP ratio close to historic lows (at 12. 7% vs. 15 to 16% for the region), erosion in revenues due to new measures passed over the last couple of years and for specific taxes, from inflation. At the same time it needs resources to address the large infrastructure and social spending deficit/backlog that is creating a drag on the country's future growth which can only get worse with time. Our infra spending is only about half the average for the region of 5% of GDP, and our education quality has slipped dismally over the years, and from being one of the highest among our peers, is now down the cellar.
2. Questions:
a. How much can the next administration depend on improving tax administration/plugging leakages to generating fiscal resources? How can this new administration generate sizeable increases in collection via improved administration considering poor track record of past administrations (and modest successes in other countries that yielded no more than 1% of GDP)?
b. Should the new administration look to new/additional taxes? VAT, excise taxes, especially on oil, text tax? How to generate public support for new taxes?
c. What reforms are needed in spending priorities to get more bang for the taxpayer buck? In budget and procurement processes?
C. Government Interventions in Imperfect and/or Important Markets. How should government intervene better in key sectors to generate inclusive sustainable growth?
1. Introduction: There are a number of key areas where there is serious lack of supply, despite clear demand, perhaps bordering on crisis proportions if unattended. Examples are in important infrastructure like power, water, and mass transport. Just to illustrate how market or government failure can lead to serious losses - consider the power crisis of 1991/92, resulting from failure to anticipate and build power plants and losses in growth and investment. Growths during those years were negative and only marginally positive, respectively, instead of what could have been at least the historic level of 4%. Even if we assume that the losses were confined only to those two years, putting aside losses from the fruits of lost investment and reputation damage, every 1% of growth forgone each year translates to P70 billion, $1.5 billion, the same price of as two Bataan Nuclear Power plants. Multiply this by 8 for the two years- that's what it cost the economy- that's P560 billion down a dark pit, lost forever. Presented this way, the losses of inaction for under provision of other important infrastructure - water, roads, mass transport, though perhaps not as staggering can be quite compelling.
2. Questions:
a. We are already seeing an increase in frequency and duration of power outages, perhaps driven by combination of factors - weather, inadequate reserves, breakdowns - what can the next administration do to prevent power crisis of the magnitude of the early '90s which is consistent with the EPIRA architecture and law? Or does the EPIRA need change?
b. In the other areas of water, mass transport, roads, how can government improve the investment climate for more public-private partnerships to augment its constrained budget for public works? Does the Philippines also need broader competition policy so that infra services become cheaper, for example in transport or power?
c. Is there a role for government providing fiscal incentives or production subsidies for particular industries or activities (say, SME financing, R and D, training) on a temporary basis until they can be competitive? What are the pitfalls to this strategy advocated by some?
D. Poverty Reduction: How can government make growth more inclusive?
1. Introduction: The Philippines now has one of the highest incidences of poverty counting over 20% of its population as having incomes below one dollar per day, higher than Vietnam, Indonesia, China. This is explained by limited dynamism of economic growth, which moreover has not translated to poverty reduction. There is likewise evidence of deterioration in the distribution of income. Factors identified by the World Bank as contributing to this deterioration include unequal, inadequate access to social services and social protection, leading to unequal sectoral and regional distribution of growth and barriers to factor mobility.
2. Questions:
a. What are the roots of poverty in the Philippines?
b. How might some of the barriers in factor mobility help reduce poverty, i.e., policy bias like legislated wages against low-skill employment, or biases vs. more efficient use of land due to agrarian reform? Too sensitive to embark on? Are there political feasible actions possible in these areas?
c. What improvements in social services and social protection are feasible, e.g., redeployment of NFA subsidies toward conditional cash transfers? What could be the possible political road map for doing this without raising obstacles on ground of food security, etc?
d. What are the other kinds of interventions should government embark in the areas of education and health, including reproductive health, that addresses the requirements of the poor that are politically feasible early on?
Mr. Romeo Bernardo is board member of The Institute for Development and Econometric Analysis, Inc. and managing director of Lazaro Bernardo Tiu & Associates, Inc. He was formerly undersecretary of Finance during the Aquino and Ramos administrations.
Monday, May 3, 2010
Economic issues for next president (part 1)
Business World
Introspective
Last April 14, I was privileged to moderate a distinguished panel of economists in the 9th Ayala Corporation-UP School of Economics Lecture Series. The panel members were Dr. Philip Medalla, former Economic Planning secretary, Dr. Ben Diokno, former Budget secretary, Dr Arsi Balisacan, former undersecretary of Agriculture, and Dr Raul Fabella, former dean of the UP School of Economics. As our invitation said: most of them had to grapple with hard economic questions, not only as academics but as senior economic managers in four administrations, dealing in real time with difficult policy trade-offs, often against strong vested interests and working through weak, sometimes even compromised institutions.
Below are my introductory remarks intended to frame the discussion. Subsequent columns will cover what they said.
I met with them a week before, and agreed, on a common set of assumptions, like good economists, that will frame the discussion.
The key one is that by end of June, we will have a credibly elected president with the Congress and the public more or less behind him. Why this is something we need to state explicitly is perhaps best illustrated by a text I got this morning.
The Social Weather Stations says President Arroyo's net satisfaction rating is down a negative 53 percent - an all-time low. Because of the 'F' or failing grade she received from Filipinos, Mrs. Arroyo, a former student of the UP School of Economics, says this. 'I am more than willing to repeat'.
Proceeding further on our assumptions:
1. He has adequate skill set and incentive to govern well which are aligned with the nation's. He will have alter-egos/teams which are similarly placed. 2. The new president needs to set a tone for his administration in the first 100 days, and perhaps success or failure during the first two years will define the rest of his term. Needs to make a mark, score victories supported by the public, and build confidence within this period, using powers at his disposal, in most cases without new legislation.
3. Key question for the administration, and the country. How to achieve that which has eluded the Philippines for many years-inclusive, sustainable growth.
4. For our discussion flow, we framed/try to break up this question into four areas and assigned a panel member to take the lead in discussing these issues: These are - a) on the overall strategy, how to restore growth after the crisis, b) the fiscal challenges of finding the resources to raise investment and social spending, c) government interventions in imperfect and/or important markets, and d) how do we reduce poverty and make growth more inclusive.
A. Overall Strategy: How to restore growth after the crisis (both global and as one panelist said - Glorial.)?
1. Intro: From what has been one of the two most promising countries in the 1950s (together with Burma), the Philippines has become one of the laggards in our region. The lack of faster growth in the Philippines has been traced by the World Bank to low investment and slow structural transformation from low-productivity to high productivity activities, especially in the last decade. This manifests itself in agriculture and manufacturing stagnating, and services sector, primarily driven by remittances from overseas, and more recently BPO employment, generating what there is of growth, and job creation. Recent diagnostic studies point to key constraints as the culprits - a) a vulnerable fiscal situation, b) inadequate infrastructure, c) weak investment climate due largely to governance concerns.
2. Questions:
a. What should be the next president's development vision for the country, given the global environment, our resource endowments, and limitations? Should we still look at the East Asian models, relying more on manufacturing as the big driver. Or is India a more relevant model, i.e., very focused on services, or even Caribbean, i.e., remittances and tourism? Other models?
b. Broadly, what can be done to overcome these binding constraints identified above of fiscal situation, inadequate infra, and weak investments?
c. Why is corruption in the Philippines seen to be such a grave disincentive to investment and doing business and a deadly drag to growth (even as we see corruption in other countries with vibrant private sector investment taking place)? What can a serious new administration do to limit corruption and/or its most pernicious consequences? To be more specific, how can an incoming administration establish credibility in this area, which we all know will take a long time to fix?
d. Is there a case for more activist policies like production subsidies and incentives to promote faster industrialization as advocated by some economists?
e. Or keeping the exchange rate undervalued as China seems to be doing, as seems to have been recently suggested in Introspective columns in BusinessWorld.?
marginally positive, respectively, instead of what could have been at least the historic level of 4%. Even if we assume that the losses were confined only to those two years, putting aside losses from the fruits of lost investment and reputation damage, every 1% of growth forgone each year translates to P70 billion, $1.5 billion, the same price of as two Bataan Nuclear Power plants. Multiply this by 8 for the two years- that's what it cost the economy- that's P560 billion down a dark pit, lost forever. Presented this way, the losses of inaction for under provision of other important infrastructure - water, roads, mass transport, though perhaps not as staggering can be quite compelling.
2. Questions:
a. We are already seeing an increase in frequency and duration of power outages, perhaps driven by combination of factors - weather, inadequate reserves, breakdowns - what can the next administration do to prevent power crisis of the magnitude of the early '90s which is consistent with the EPIRA architecture and law? Or does the EPIRA need change?
b. In the other areas of water, mass transport, roads, how can government improve the investment climate for more public-private partnerships to augment its constrained budget for public works? Does the Philippines also need broader competition policy so that infra services become cheaper, for example in transport or power?
c. Is there a role for government providing fiscal incentives or production subsidies for particular industries or activities (say, SME financing, R and D, training) on a temporary basis until they can be competitive? What are the pitfalls to this strategy advocated by some?
D. Poverty Reduction: How can government make growth more inclusive?
1. Introduction: The Philippines now has one of the highest incidences of poverty counting over 20% of its population as having incomes below one dollar per day, higher than Vietnam, Indonesia, China. This is explained by limited dynamism of economic growth, which moreover has not translated to poverty reduction. There is likewise evidence of deterioration in the distribution of income. Factors identified by the World Bank as contributing to this deterioration include unequal, inadequate access to social services and social protection, leading to unequal sectoral and regional distribution of growth and barriers to factor mobility.
2. Questions:
a. What are the roots of poverty in the Philippines?
b. How might some of the barriers in factor mobility help reduce poverty, i.e., policy bias like legislated wages against low-skill employment, or biases vs. more efficient use of land due to agrarian reform? Too sensitive to embark on? Are there political feasible actions possible in these areas?
c. What improvements in social services and social protection are feasible, e.g., redeployment of NFA subsidies toward conditional cash transfers? What could be the possible political road map for doing this without raising obstacles on ground of food security, etc?
d. What are the other kinds of interventions should government embark in the areas of education and health, including reproductive health, that addresses the requirements of the poor that are politically feasible early on?
Introspective
Last April 14, I was privileged to moderate a distinguished panel of economists in the 9th Ayala Corporation-UP School of Economics Lecture Series. The panel members were Dr. Philip Medalla, former Economic Planning secretary, Dr. Ben Diokno, former Budget secretary, Dr Arsi Balisacan, former undersecretary of Agriculture, and Dr Raul Fabella, former dean of the UP School of Economics. As our invitation said: most of them had to grapple with hard economic questions, not only as academics but as senior economic managers in four administrations, dealing in real time with difficult policy trade-offs, often against strong vested interests and working through weak, sometimes even compromised institutions.
Below are my introductory remarks intended to frame the discussion. Subsequent columns will cover what they said.
I met with them a week before, and agreed, on a common set of assumptions, like good economists, that will frame the discussion.
The key one is that by end of June, we will have a credibly elected president with the Congress and the public more or less behind him. Why this is something we need to state explicitly is perhaps best illustrated by a text I got this morning.
The Social Weather Stations says President Arroyo's net satisfaction rating is down a negative 53 percent - an all-time low. Because of the 'F' or failing grade she received from Filipinos, Mrs. Arroyo, a former student of the UP School of Economics, says this. 'I am more than willing to repeat'.
Proceeding further on our assumptions:
1. He has adequate skill set and incentive to govern well which are aligned with the nation's. He will have alter-egos/teams which are similarly placed. 2. The new president needs to set a tone for his administration in the first 100 days, and perhaps success or failure during the first two years will define the rest of his term. Needs to make a mark, score victories supported by the public, and build confidence within this period, using powers at his disposal, in most cases without new legislation.
3. Key question for the administration, and the country. How to achieve that which has eluded the Philippines for many years-inclusive, sustainable growth.
4. For our discussion flow, we framed/try to break up this question into four areas and assigned a panel member to take the lead in discussing these issues: These are - a) on the overall strategy, how to restore growth after the crisis, b) the fiscal challenges of finding the resources to raise investment and social spending, c) government interventions in imperfect and/or important markets, and d) how do we reduce poverty and make growth more inclusive.
A. Overall Strategy: How to restore growth after the crisis (both global and as one panelist said - Glorial.)?
1. Intro: From what has been one of the two most promising countries in the 1950s (together with Burma), the Philippines has become one of the laggards in our region. The lack of faster growth in the Philippines has been traced by the World Bank to low investment and slow structural transformation from low-productivity to high productivity activities, especially in the last decade. This manifests itself in agriculture and manufacturing stagnating, and services sector, primarily driven by remittances from overseas, and more recently BPO employment, generating what there is of growth, and job creation. Recent diagnostic studies point to key constraints as the culprits - a) a vulnerable fiscal situation, b) inadequate infrastructure, c) weak investment climate due largely to governance concerns.
2. Questions:
a. What should be the next president's development vision for the country, given the global environment, our resource endowments, and limitations? Should we still look at the East Asian models, relying more on manufacturing as the big driver. Or is India a more relevant model, i.e., very focused on services, or even Caribbean, i.e., remittances and tourism? Other models?
b. Broadly, what can be done to overcome these binding constraints identified above of fiscal situation, inadequate infra, and weak investments?
c. Why is corruption in the Philippines seen to be such a grave disincentive to investment and doing business and a deadly drag to growth (even as we see corruption in other countries with vibrant private sector investment taking place)? What can a serious new administration do to limit corruption and/or its most pernicious consequences? To be more specific, how can an incoming administration establish credibility in this area, which we all know will take a long time to fix?
d. Is there a case for more activist policies like production subsidies and incentives to promote faster industrialization as advocated by some economists?
e. Or keeping the exchange rate undervalued as China seems to be doing, as seems to have been recently suggested in Introspective columns in BusinessWorld.?
marginally positive, respectively, instead of what could have been at least the historic level of 4%. Even if we assume that the losses were confined only to those two years, putting aside losses from the fruits of lost investment and reputation damage, every 1% of growth forgone each year translates to P70 billion, $1.5 billion, the same price of as two Bataan Nuclear Power plants. Multiply this by 8 for the two years- that's what it cost the economy- that's P560 billion down a dark pit, lost forever. Presented this way, the losses of inaction for under provision of other important infrastructure - water, roads, mass transport, though perhaps not as staggering can be quite compelling.
2. Questions:
a. We are already seeing an increase in frequency and duration of power outages, perhaps driven by combination of factors - weather, inadequate reserves, breakdowns - what can the next administration do to prevent power crisis of the magnitude of the early '90s which is consistent with the EPIRA architecture and law? Or does the EPIRA need change?
b. In the other areas of water, mass transport, roads, how can government improve the investment climate for more public-private partnerships to augment its constrained budget for public works? Does the Philippines also need broader competition policy so that infra services become cheaper, for example in transport or power?
c. Is there a role for government providing fiscal incentives or production subsidies for particular industries or activities (say, SME financing, R and D, training) on a temporary basis until they can be competitive? What are the pitfalls to this strategy advocated by some?
D. Poverty Reduction: How can government make growth more inclusive?
1. Introduction: The Philippines now has one of the highest incidences of poverty counting over 20% of its population as having incomes below one dollar per day, higher than Vietnam, Indonesia, China. This is explained by limited dynamism of economic growth, which moreover has not translated to poverty reduction. There is likewise evidence of deterioration in the distribution of income. Factors identified by the World Bank as contributing to this deterioration include unequal, inadequate access to social services and social protection, leading to unequal sectoral and regional distribution of growth and barriers to factor mobility.
2. Questions:
a. What are the roots of poverty in the Philippines?
b. How might some of the barriers in factor mobility help reduce poverty, i.e., policy bias like legislated wages against low-skill employment, or biases vs. more efficient use of land due to agrarian reform? Too sensitive to embark on? Are there political feasible actions possible in these areas?
c. What improvements in social services and social protection are feasible, e.g., redeployment of NFA subsidies toward conditional cash transfers? What could be the possible political road map for doing this without raising obstacles on ground of food security, etc?
d. What are the other kinds of interventions should government embark in the areas of education and health, including reproductive health, that addresses the requirements of the poor that are politically feasible early on?
Monday, April 5, 2010
Power, interrupted
Business World
Introspective
The current electricity shortage in the country is stirring up memories of the power crisis in the early 1990s when daily blackouts of as long as 12 hours in Manila pushed investors to the exit causing economic output to contract.
I wrote a report a week back for GlobalSource, a global network of independent analysts, explaining how the current shortage differs from that of 20 years ago, noting that:
1. Power outages today are not due to an acute shortage of power generating capacities but have been triggered by an El Nino-induced drought, hence the surprising severity especially in Mindanao, which relies on hydroelectric plants for over 50% of its electricity needs.
2. Severe power outages have so far been limited to Mindanao; in comparison, power interruptions in Luzon, which depends much less on hydroelectric plants (about 10% and less than 1% in Visayas), have been intermittent and of much shorter duration.
Thus, in the near term, from a macroeconomic perspective:
3. Mindanao's less than 20% contribution to economic growth (vs. two- thirds for Luzon), while not insignificant, is not expected to cut into overall growth appreciably.
4. Despite the more than doubling of spot prices, the impact on electric bills are expected to be muted as utilities are allowed full recovery only on 10% of their purchases from the wholesale electricity spot market (WESM) while any excess purchases are recoverable based on time-of- use rates of the National Power Corp. (NPC).
The big picture
Still, beyond election and short-term macroeconomic risks, incidents of massive blackouts in a country that has a history of power shortage and where competitiveness is dragged down by high power costs, tend to undermine investor confidence further and raise the hurdle rate on investments. This risks underinvestment all around resulting in an inability to expand the country's growth frontier, thus bringing forward to the present the issue of long-term supply adequacy.
The Department of Energy's power supply and demand outlook does not provide much comfort. For Luzon, government estimates the critical period, when existing generating capacity will not be able to meet peak demand plus a 23% reserve margin, to come as early as 2011. Private industry estimates range from 2012 to 2014, which nevertheless also point to the need for capacity additions today.
Meanwhile, the critical period has come and gone for Visayas, which has been experiencing rotating blackouts for a couple of years already before the construction of a new baseload coal plant, expected on stream by the third quarter this year. Mindanao is also expected to face power shortages this year, albeit the current severity has not been anticipated.
In sum, the supply/demand outlook reveals the need for immediate new investments in power generating capacity, especially considering the three year lead time needed to get all the requirements and financing for building power plants. Indeed, industry experts are one in saying that shortages even in Luzon would have happened already had it not been for the following developments: (i) lower economic growth due to the global financial crisis, (ii) higher dependence of recent past growth on the services sector which is less energy intensive, versus the manufacturing sector which has been losing out to China, (iii) rehabilitation and better maintenance of privatized plants which have translated into higher energy sales, and (iv) functioning of the WESM with peak/off-peak pricing that encourages optimized energy dispatch to improve returns and spread out power demand.
Work in progress
To be sure, investor interest of late can be gleaned from successes in government auctions of existing assets - after much delay, over 80% of government's power generating assets is finally in private hands. It has been much more difficult to get them to put up new baseload plants without open access, where electricity buyers of a certain size can freely shop for suppliers.
Thus far, investors find simply buying existing public generating assets the easier route to participating in the local power industry. Moreover, the transition supply contracts that come with the plants help to ease the way into complete merchant plants that will operate in an uncertain regime.
The Energy Regulatory Board is expected to soon issue rules on open access on a voluntary basis, ahead of the Power Sector Assets and Liabilities Management Corporation (PSALM) achieving the threshold. It is hoped that this will help investors see the emerging landscape and make business decisions to address Luzon's power needs anticipatorily.
Also, the WESM, introduced in 2006, continues to have rules that undermine price discovery and is thus unable to telegraph shortages through price signals. Instead, it has been observed that WESM prices have tended to be artificially depressed due to the operation of government's must run plants whenever there are supply disruptions on the private side that results in spot prices not reflecting the true scarcity of electricity.
Unlike fiscal sustainability which boils down to a taxing problem, it is less clear to us, based on the economic platforms presented so far by leading presidential contenders, how the winning candidate will tackle power sector issues, which are in truth much more complex. Even if the next administration learned the lesson of 20 years ago, i.e., to be anticipatory and not wait for a crisis to happen before acting which imposes huge costs on the economy, rules have changed under the Electric Power Industry Reform Act (EPIRA). EPIRA now bars government, except with Congress's approval, from doing what the Ramos administration did in 1992- 93 to solve the power crisis then, i.e., enter into energy purchase contracts with independent power producers.
A worst case scenario, if the next administration dilly-dallies, will see a repeat of the end of Aquino administration power crisis that will seriously damage investor confidence, pull down economic output. and lead to expensive solutions that will affect the country's long-term competitiveness. A rough calculation, based on the $1-million-per megawatt rule of thumb for costing power plants, indicates that every foregone 1% of GDP growth translates into over P70 billion of loss per year for the economy, which is enough to pay for a 1500-MW power plant. When viewed in the context of a negative growth rate in 1991 and near zero in 1992, the losses can be quiet staggering if the next administration fails to avert another power crisis.
We remain optimistic though that with memories of the last crisis still fresh in the minds of people now holding decision-making posts, the next administration will have enough political will to iron out kinks in the present setup and do enough to give comfort by way of improved regulatory and macroeconomic environment to investors and lenders before reserves dwindle further in the main grid. If investors continue to shy away, we expect it to be able to find interim measures involving public provision that do not run afoul of the EPIRA, a far second best option though.
This was based on a report with the same title by Christine Tang and the column writer for Global Source, a network of independent analysts.
Mr. Romeo Bernardo is board member of The Institute for Development and Econometric Analysis, Inc. and managing director of Lazaro Bernardo Tiu & Associates, Inc. He was formerly undersecretary of Finance during the Aquino and Ramos administrations.
Introspective
The current electricity shortage in the country is stirring up memories of the power crisis in the early 1990s when daily blackouts of as long as 12 hours in Manila pushed investors to the exit causing economic output to contract.
I wrote a report a week back for GlobalSource, a global network of independent analysts, explaining how the current shortage differs from that of 20 years ago, noting that:
1. Power outages today are not due to an acute shortage of power generating capacities but have been triggered by an El Nino-induced drought, hence the surprising severity especially in Mindanao, which relies on hydroelectric plants for over 50% of its electricity needs.
2. Severe power outages have so far been limited to Mindanao; in comparison, power interruptions in Luzon, which depends much less on hydroelectric plants (about 10% and less than 1% in Visayas), have been intermittent and of much shorter duration.
Thus, in the near term, from a macroeconomic perspective:
3. Mindanao's less than 20% contribution to economic growth (vs. two- thirds for Luzon), while not insignificant, is not expected to cut into overall growth appreciably.
4. Despite the more than doubling of spot prices, the impact on electric bills are expected to be muted as utilities are allowed full recovery only on 10% of their purchases from the wholesale electricity spot market (WESM) while any excess purchases are recoverable based on time-of- use rates of the National Power Corp. (NPC).
The big picture
Still, beyond election and short-term macroeconomic risks, incidents of massive blackouts in a country that has a history of power shortage and where competitiveness is dragged down by high power costs, tend to undermine investor confidence further and raise the hurdle rate on investments. This risks underinvestment all around resulting in an inability to expand the country's growth frontier, thus bringing forward to the present the issue of long-term supply adequacy.
The Department of Energy's power supply and demand outlook does not provide much comfort. For Luzon, government estimates the critical period, when existing generating capacity will not be able to meet peak demand plus a 23% reserve margin, to come as early as 2011. Private industry estimates range from 2012 to 2014, which nevertheless also point to the need for capacity additions today.
Meanwhile, the critical period has come and gone for Visayas, which has been experiencing rotating blackouts for a couple of years already before the construction of a new baseload coal plant, expected on stream by the third quarter this year. Mindanao is also expected to face power shortages this year, albeit the current severity has not been anticipated.
In sum, the supply/demand outlook reveals the need for immediate new investments in power generating capacity, especially considering the three year lead time needed to get all the requirements and financing for building power plants. Indeed, industry experts are one in saying that shortages even in Luzon would have happened already had it not been for the following developments: (i) lower economic growth due to the global financial crisis, (ii) higher dependence of recent past growth on the services sector which is less energy intensive, versus the manufacturing sector which has been losing out to China, (iii) rehabilitation and better maintenance of privatized plants which have translated into higher energy sales, and (iv) functioning of the WESM with peak/off-peak pricing that encourages optimized energy dispatch to improve returns and spread out power demand.
Work in progress
To be sure, investor interest of late can be gleaned from successes in government auctions of existing assets - after much delay, over 80% of government's power generating assets is finally in private hands. It has been much more difficult to get them to put up new baseload plants without open access, where electricity buyers of a certain size can freely shop for suppliers.
Thus far, investors find simply buying existing public generating assets the easier route to participating in the local power industry. Moreover, the transition supply contracts that come with the plants help to ease the way into complete merchant plants that will operate in an uncertain regime.
The Energy Regulatory Board is expected to soon issue rules on open access on a voluntary basis, ahead of the Power Sector Assets and Liabilities Management Corporation (PSALM) achieving the threshold. It is hoped that this will help investors see the emerging landscape and make business decisions to address Luzon's power needs anticipatorily.
Also, the WESM, introduced in 2006, continues to have rules that undermine price discovery and is thus unable to telegraph shortages through price signals. Instead, it has been observed that WESM prices have tended to be artificially depressed due to the operation of government's must run plants whenever there are supply disruptions on the private side that results in spot prices not reflecting the true scarcity of electricity.
Unlike fiscal sustainability which boils down to a taxing problem, it is less clear to us, based on the economic platforms presented so far by leading presidential contenders, how the winning candidate will tackle power sector issues, which are in truth much more complex. Even if the next administration learned the lesson of 20 years ago, i.e., to be anticipatory and not wait for a crisis to happen before acting which imposes huge costs on the economy, rules have changed under the Electric Power Industry Reform Act (EPIRA). EPIRA now bars government, except with Congress's approval, from doing what the Ramos administration did in 1992- 93 to solve the power crisis then, i.e., enter into energy purchase contracts with independent power producers.
A worst case scenario, if the next administration dilly-dallies, will see a repeat of the end of Aquino administration power crisis that will seriously damage investor confidence, pull down economic output. and lead to expensive solutions that will affect the country's long-term competitiveness. A rough calculation, based on the $1-million-per megawatt rule of thumb for costing power plants, indicates that every foregone 1% of GDP growth translates into over P70 billion of loss per year for the economy, which is enough to pay for a 1500-MW power plant. When viewed in the context of a negative growth rate in 1991 and near zero in 1992, the losses can be quiet staggering if the next administration fails to avert another power crisis.
We remain optimistic though that with memories of the last crisis still fresh in the minds of people now holding decision-making posts, the next administration will have enough political will to iron out kinks in the present setup and do enough to give comfort by way of improved regulatory and macroeconomic environment to investors and lenders before reserves dwindle further in the main grid. If investors continue to shy away, we expect it to be able to find interim measures involving public provision that do not run afoul of the EPIRA, a far second best option though.
This was based on a report with the same title by Christine Tang and the column writer for Global Source, a network of independent analysts.
Mr. Romeo Bernardo is board member of The Institute for Development and Econometric Analysis, Inc. and managing director of Lazaro Bernardo Tiu & Associates, Inc. He was formerly undersecretary of Finance during the Aquino and Ramos administrations.
Monday, March 15, 2010
The good, bad, and somewhat stupid
Business World
In an earlier column, I wrote about The Fiscal Imperatives for the Next Administration (No Money, No Honey) focusing on tax policy reform needed to sustain macro-stability and provide the much-needed resources for infrastructure and social spending.
This time, allow me to talk about how our government uses, well or badly, fiscal policy tools to help members of society who need help, focusing on recent programs for the poor and the elderly.
The good: Conditional cash transfers
Learning from the successful experience of two dozen countries, notably Indonesia and Brazil, to get maximum bang for the taxpayer buck to help reduce poverty, the administration, with the full technical and financial support of the World Bank, launched its own conditional cash transfer program under the banner of Pantawid Pamilyang Pilipino Program (4 Ps). It provides a monthly stipend of up to P1,400 (P500 per household for health and nutritional expenses and P300 per child for educational expenses up to a maximum of three children) to the poorest households of a community provided the children are kept in school. The DSWD selects the beneficiaries based on the targeting system developed for the program.
Despite apprehensions that this may end up being no different from many past programs done in the name of the poor that have ended up at best as wasteful political showcases, this program is showing good early results. Children are going back to school and getting immunized, while their mothers are having pre- and post-natal care. What it can achieve at the end of the day is to break, for the next generation, the cycle of poverty - poor nutrition, poor health, poor education, and resulting unemployment and impoverishment.
The credit for this program goes to highly regarded DSWD Secretary Esperanza Cabral, and of course, the full support of President Gloria Macapagal Arroyo who clearly saw not just the economic soundness of the program, but also its political benefits. (A professor friend who served in the Estrada administration quipped that the appointment of the right person for DSWD secretary is one area where President Arroyo did better than his boss.)
The bad: Nfa
Ask any good economist what is the biggest waste of government resources in recent years and he will readily point to the NFA program of rice subsidies. As a subsidy program it fails the needs test since the subsidized rice is available to all, whether rich or poor. Indeed, studies have shown that less than 25% of the poor have access to NFA rice. Worse, it is quite likely that a large fraction - maybe more than half - of the rice is sold by the NFA at the official government price to some lucky people who repack the NFA rice and re-sell them at market prices. According to a recent World Bank study, it costs the NFA an estimated average of P5 to deliver P1 of subsidy to the poor, the big number reflecting the wastes, leakages, and the governance deficit in its administration. It does nothing for the poor farmers who especially at a time of high rice prices (like now) are deprived the benefits of a remunerative price. On a more fundamental level, it distorts market signals and misallocates resources in the agricultural sector and rest of the economy. Finally, it is very expensive: in 2008, NFA lost P37 billion per data from the Philippine Institute of Development Studies. According to the World Bank, this may have racked up to P63 billion in 2009 (coming from losses that averaged only P5 billion annually in earlier years).
Many studies have been written on why NFA needs to be re-engineered, and how better off consumers and farmers would be if funding is redirected as targeted subsidies to poor consumers and invested in productive assets like rural infrastructure to help farmers. (You can view the most recent one in the November quarterly report of the World Bank - Towards an Inclusive Recovery at http://siteresources.worldbank.org/INTPHILIPPINES/Resources/PHLQuarterly November2009FINAL.pdf) Indeed, generations of technocrats in NEDA, Finance, and the Department of Agriculture, assisted by multilateral and bilateral institutions, have tried to push for reform without success. The vested interests are just too entrenched, and the rents too much.
Contrast the cost of NFA with the cost of the conditional cash transfer. The P10 billion this year under the 4Ps program will benefit around 3.5 million people. Consider what this means: If we had shut down NFA last year and diverted the P63 billion to a conditional cash transfer program, we would have been able to cover 100% of the country's poor (against the 25% with NFA), with each household receiving 7 times the benefits!
(The next president, whoever he may be, can't do better than reappoint Secretary Cabral to see this program move to a higher level, perhaps refined to include conditions covering other socially desirable objectives like reproductive health. NB. I have never had the privilege of meeting Dr. Cabral.)
The somewhat stupid
Despite strong recommendation from the secretary of Finance for her to veto it, the President recently signed into law a bill that would give exemptions from VAT for purchases of senior citizens for restaurant food, medicines, transportation, and movies. Like many tax exemption bills, one cannot find fault with the objectives - in this case to help the elderly, most of whom no longer receive current income. Indeed one can even argue that the amount of tax leakage is not that large, at least compared to NFA deficits, only P1.68 billion per DoF estimate; so it is not that bad from a fiscal standpoint.
However, it is somewhat stupid. Why? Because there are so many other ways of helping the elderly without reaping the unintended consequences of creating a loophole in the VAT system that create a compliance and administration nightmare, or be vulnerable to abuse by crooked traders and BIR agents. The most straightforward way is the one suggested by the Department of Finance: simply raise the discount from 20% to 30%, thus restoring the savings to the elderly that the VAT law is supposed to have deprived. The stores will simply recoup this additional expense from sales to other customers.
This will also keep the integrity and efficiency of the VAT system, one which is self policing - somebody's credit is somebody else's payment - and does not create precedence for others to clamor for the same. (Doesn't society care for the young? Why not exempt children's medicines and baby milk from VAT? How about purchases of the handicapped? Or of our soldiers, teachers, or OFWs?)
If we want to help the elderly poor, how about conditional cash transfer for them? Isn't this much better than this prime example of poorly thought out, politics of pander, VAT exemption for seniors that subsidizes in proportion to one's purchases, to the richer, the more subsidy and for the poorest, nada?
More fundamentally, if we are to improve revenue collection and maintain macrostability, we need to make our tax system - already complicated, full of discretion and loopholes - simple and easy to administer. Let us not overburden it further. Let us instead use expenditure policy to help the poor and the elderly, or for that matter all other sectors asking special support like industries seeking/enjoying fiscal incentives. This way, it is transparent, targeted and needs based, and subject to annual evaluation if still deserving, all under the discipline of a budget process.
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.
In an earlier column, I wrote about The Fiscal Imperatives for the Next Administration (No Money, No Honey) focusing on tax policy reform needed to sustain macro-stability and provide the much-needed resources for infrastructure and social spending.
This time, allow me to talk about how our government uses, well or badly, fiscal policy tools to help members of society who need help, focusing on recent programs for the poor and the elderly.
The good: Conditional cash transfers
Learning from the successful experience of two dozen countries, notably Indonesia and Brazil, to get maximum bang for the taxpayer buck to help reduce poverty, the administration, with the full technical and financial support of the World Bank, launched its own conditional cash transfer program under the banner of Pantawid Pamilyang Pilipino Program (4 Ps). It provides a monthly stipend of up to P1,400 (P500 per household for health and nutritional expenses and P300 per child for educational expenses up to a maximum of three children) to the poorest households of a community provided the children are kept in school. The DSWD selects the beneficiaries based on the targeting system developed for the program.
Despite apprehensions that this may end up being no different from many past programs done in the name of the poor that have ended up at best as wasteful political showcases, this program is showing good early results. Children are going back to school and getting immunized, while their mothers are having pre- and post-natal care. What it can achieve at the end of the day is to break, for the next generation, the cycle of poverty - poor nutrition, poor health, poor education, and resulting unemployment and impoverishment.
The credit for this program goes to highly regarded DSWD Secretary Esperanza Cabral, and of course, the full support of President Gloria Macapagal Arroyo who clearly saw not just the economic soundness of the program, but also its political benefits. (A professor friend who served in the Estrada administration quipped that the appointment of the right person for DSWD secretary is one area where President Arroyo did better than his boss.)
The bad: Nfa
Ask any good economist what is the biggest waste of government resources in recent years and he will readily point to the NFA program of rice subsidies. As a subsidy program it fails the needs test since the subsidized rice is available to all, whether rich or poor. Indeed, studies have shown that less than 25% of the poor have access to NFA rice. Worse, it is quite likely that a large fraction - maybe more than half - of the rice is sold by the NFA at the official government price to some lucky people who repack the NFA rice and re-sell them at market prices. According to a recent World Bank study, it costs the NFA an estimated average of P5 to deliver P1 of subsidy to the poor, the big number reflecting the wastes, leakages, and the governance deficit in its administration. It does nothing for the poor farmers who especially at a time of high rice prices (like now) are deprived the benefits of a remunerative price. On a more fundamental level, it distorts market signals and misallocates resources in the agricultural sector and rest of the economy. Finally, it is very expensive: in 2008, NFA lost P37 billion per data from the Philippine Institute of Development Studies. According to the World Bank, this may have racked up to P63 billion in 2009 (coming from losses that averaged only P5 billion annually in earlier years).
Many studies have been written on why NFA needs to be re-engineered, and how better off consumers and farmers would be if funding is redirected as targeted subsidies to poor consumers and invested in productive assets like rural infrastructure to help farmers. (You can view the most recent one in the November quarterly report of the World Bank - Towards an Inclusive Recovery at http://siteresources.worldbank.org/INTPHILIPPINES/Resources/PHLQuarterly November2009FINAL.pdf) Indeed, generations of technocrats in NEDA, Finance, and the Department of Agriculture, assisted by multilateral and bilateral institutions, have tried to push for reform without success. The vested interests are just too entrenched, and the rents too much.
Contrast the cost of NFA with the cost of the conditional cash transfer. The P10 billion this year under the 4Ps program will benefit around 3.5 million people. Consider what this means: If we had shut down NFA last year and diverted the P63 billion to a conditional cash transfer program, we would have been able to cover 100% of the country's poor (against the 25% with NFA), with each household receiving 7 times the benefits!
(The next president, whoever he may be, can't do better than reappoint Secretary Cabral to see this program move to a higher level, perhaps refined to include conditions covering other socially desirable objectives like reproductive health. NB. I have never had the privilege of meeting Dr. Cabral.)
The somewhat stupid
Despite strong recommendation from the secretary of Finance for her to veto it, the President recently signed into law a bill that would give exemptions from VAT for purchases of senior citizens for restaurant food, medicines, transportation, and movies. Like many tax exemption bills, one cannot find fault with the objectives - in this case to help the elderly, most of whom no longer receive current income. Indeed one can even argue that the amount of tax leakage is not that large, at least compared to NFA deficits, only P1.68 billion per DoF estimate; so it is not that bad from a fiscal standpoint.
However, it is somewhat stupid. Why? Because there are so many other ways of helping the elderly without reaping the unintended consequences of creating a loophole in the VAT system that create a compliance and administration nightmare, or be vulnerable to abuse by crooked traders and BIR agents. The most straightforward way is the one suggested by the Department of Finance: simply raise the discount from 20% to 30%, thus restoring the savings to the elderly that the VAT law is supposed to have deprived. The stores will simply recoup this additional expense from sales to other customers.
This will also keep the integrity and efficiency of the VAT system, one which is self policing - somebody's credit is somebody else's payment - and does not create precedence for others to clamor for the same. (Doesn't society care for the young? Why not exempt children's medicines and baby milk from VAT? How about purchases of the handicapped? Or of our soldiers, teachers, or OFWs?)
If we want to help the elderly poor, how about conditional cash transfer for them? Isn't this much better than this prime example of poorly thought out, politics of pander, VAT exemption for seniors that subsidizes in proportion to one's purchases, to the richer, the more subsidy and for the poorest, nada?
More fundamentally, if we are to improve revenue collection and maintain macrostability, we need to make our tax system - already complicated, full of discretion and loopholes - simple and easy to administer. Let us not overburden it further. Let us instead use expenditure policy to help the poor and the elderly, or for that matter all other sectors asking special support like industries seeking/enjoying fiscal incentives. This way, it is transparent, targeted and needs based, and subject to annual evaluation if still deserving, all under the discipline of a budget process.
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.
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