Beyond chugging along

Business World
Introspective

A COMMON question raised at the height of the 2008/09 financial crisis was Why was the Philippines spared by the savage global financial storm in the high seas? The answer: The Philippine ship never left port. I may have actually first heard that during the 1997 Asian Financial crisis. I do not hear that half joke repeated too much these days; indeed, things are looking up.

The Philippines is better situated today than for as long as many of us can remember. Objective financial indicators show this - robust gross international reserves, manageable and declining public debt ratios, being a net external creditor to the world, healthy banking statistics. Our global competitive ranking has zoomed by a remarkable 10 places for the second year in a row. The ADB upgraded forecasts of Philippine growth, already among the highest in the region, even while downgrading everyone else (more recently, the World Bank and IMF did; as have we at GlobalSource, months earlier). A respected professor and monetary official has been quoted as saying we are practically invulnerable to external shocks.

Indeed, our consumption-based economy, driven by sturdy OFW remittances, a very competitive BPO sector and our growth-favored demographics, is expected to stay resilient even in the face of elevated risk warnings from the IMF (risks of a serious global slowdown are alarmingly high). This resiliency has been tested during the subprime triggered global recession of 2008/2009 where we continued to chug along during the worse of it.

We will likely continue to do so, short of severe fat tail risks materializing. Among such, a default of one of the periphery Eurozone countries and its contagion effects globally on confidence, financial market stability, growth, in a downward spiral, is probably what worries most. (There are others - Israel surgically attacking Iran's nuclear sites leading to oil supply disruptions, a flare-up in the contested Asian seas/shoals, etc.)

While we need to be conscious of possible disruptions such external shocks can inflict on our economy, what I worry about most is homegrown. That is, of us failing to fully seize as a nation, the opportunities that our comfortable fiscal and external finances, new windows for attracting investments, and most importantly - credible leadership - have opened for us to scale a higher growth path.

The President and his team are mindful of this. The Philippine Development Plan targets 7%-8% growth. Secretary Purisima has recently expressed the same target in a recent upbeat article about the country in the Financial Times. This is a growth rate twice as fast as in the last decade.

The challenge for the Philippines is to attract enough investment and job creation above the comfort zone of 3%-4% growth created by the remittances of our citizens who toil abroad to support their families at home and the growing BPO sector which can only employ a tiny fraction of our people.

An excellent document issued by the private-sector Arangkada Philippines: A Business Perspective (http://www.arangkadaphilippines.com) identifies the reform measures that are needed to achieve this kind of growth acceleration. From a presentation of its principal author, John Forbes of the Joint Foreign Chambers earlier this year, I believe the administration scores a good based on progress achieved in the 472 reform measures identified (details available in the Web site).

Where can such growth come from?

The administration has just adopted a mining policy that will discourage new projects for the next few years, so let's not count on mining for new jobs or tax revenue in the near term. But agribusiness remains promising if we can improve infrastructure and create a post-CARP environment that encourages corporate farming, alongside cooperatives and small farmers. The focus of the administration is on rice self sufficiency, whereby bulk of the DA (including a still unreformed NFA) budget is devoted to a low-value crop instead of infrastructure and services that would help farmers achieve income self sufficiency by creating opportunities in other areas in the rural sector. It's puzzling for every economist I have spoken with.

There is also immense opportunity in manufacturing brought about by major relocations from Japan and China due to such factors as higher energy costs and yen appreciation in Japan and anti-foreign (especially anti- Japanese) sentiments, rising labor cost, and the appreciating renminbi in China. Thailand faces shortages of young workers and threat of future flooding while Vietnam is struggling with macro-imbalances. Flexibility in labor policies to make the Philippines more competitive is critical.

The idea of Labor Employment Zones, propounded by Dr. Gerry Sicat would be a good way to attract large labor using enterprises in manufacturing and agricultural processing to establish here. Their main feature is that the zones will be exempt from the application of the minimum wage regulation and from other regulations against fixed-term contracts and on the regularization of workers.

Poor infrastructure, both hard and soft (education, health) is frequently cited as deterring investments. PPP can play a role in attracting private investment in some infra areas that are financially attractive, or can be made so through viability gap funding. However, government will need to have a coherent long-term infrastructure plan (the Public Investment Program is still not out) and be more deliberate and clear in identifying the areas where private sector involvement is sought, and move with judicious speed in developing bankable projects for bidding out such.

Durable public finances is a key element for providing the public funding components of PPP, as well as for fully government-funded projects. The latter are still expected to account for the much larger part of infra investments by far.

In this connection, passage of the sin tax reform bill, now in the middle of hot debate in the Senate, and in the public arena, is seen by many, notably credit rating agencies, as a test of the administration's resolve to achieve its economic and governance legacy. For over two decades, dominant tobacco and alcohol producers have been successful in blocking reform, such that the present system continues to yield low and declining revenues from sin taxes due to non-price indexation and a discounted tax rate.

Based on a case study Christine Tang and I did for a forthcoming ADB book, Political Economy of the Reformed Value-Added Tax in the Philippines (Chapter 2), I think it will take nothing less than the President's strong intervention with legislators to get this through in any form resembling what the DoF submitted to Congress. Such was successfully done by his predecessor in the case of the reformed VAT law, and in a likewise defining issue for his administration, by him, in the Corona impeachment trial.

Romeo L. Bernardo is Philippine advisor of GlobalSource and a board member of the Institute for Development and Econometric Analysis, Inc. He was Undersecretary of Finance during the Aquino 1 and Ramos administrations.

Growth forecast hiked anew

Business World
by: Kathleen A. Martin


CONSULTANCY GlobalSource Partners has hiked its 2012 Philippine growth forecast anew, citing robust domestic demand and continued government spending.

Economists Romeo L. Bernardo and Margarita D. Gonzales, in a Sept. 11, report upgraded their full-year gross domestic product (GDP) growth to 5.8% from 5.5%, near the high end of government's 5-6% target.

This is the third time the US-based consultancy has revised its 2012 outlook: from 4.5% last December, the forecast was changed to 5% in June then to 5.5% last Aug. 31.

The first recast followed better than expected GDP growth of 6.3% in the first quarter and the second came after the second quarter's 5.9% result.

Robust domestic demand should be able to bring full-year growth to between 5.5% and 6% this year, Mr. Bernardo and Ms. Gonzales said.

They noted this would be supported by remittances from Filipinos working abroad, although a peso strengthening may weaken the spending power of families receiving the money.

Aside from consumer demand boosting the economy, the economists said government spending would further drive GDP growth.

The recovery in public spending this year, especially on construction, has certainly helped boost domestic demand... With outlays still way below program government has some fiscal room to maneuver in the event of a downturn, Mr. Bernardo and Ms. Gonzales said, projecting a 2.5% deficit to GDP ratio.

The economists tagged a decline in exports a threat to growth as global uncertainties remained.

Another export slowdown remains a sharp risk, as muddling-through continues in advanced economies including the US, though we should see policy responses coming from China, they said.

There is also the possibility of a sustained uptrend in oil prices as Middle East tensions persist, Mr. Bernardo and Ms. Gonzales added.

The best case scenario, they said, would be a global turnaround leading to a pickup in exports and remittances.

This could also help unlock the billions of dollars in FDIs (foreign direct investments) reportedly pledged by foreign firms through the country's export-oriented special economic zones, they said.

In the worst case, there is sharp deterioration in the euro zone with a possible default of its weaker members, though we believe the fallout can be contained with coordinated global policy action.

Both economists, meanwhile, expect GDP growth to slow to 5.5% next year, again due to global uncertainties.

Still, 2013 being an election year, we may see upside surprises depending on how well the ruling party can mobilize domestic spending, Mr. Bernardo and Ms. Gonzales said.

Consultancy firm revises Philippine growth forecasts

Business World
Top Stories

US-based consultancy firm GlobalSource Partners has upgraded its full- year gross domestic product (GDP) growth forecast for the Philippines following the release this week of encouraging second quarter data.

Analysts Romeo L. Bernardo and Margarita D. Gonzales, banking on strong consumer demand in the first semester, hiked their 2012 GDP outlook to 5.5% from 5%,

All in all, despite slowing momentum, domestic demand seems strong enough in H1 to bring full-year growth to above 5% this year -- likely closer to 5.5% in our estimate, Mr. Bernardo and Ms. Gonzales said in an Aug. 30 market brief.

It was the second revision for the year for GlobalSource, which in June upgraded its original 2012 outlook of 4.5% to 5%, also citing strong domestic demand.

The forecast remains within the official 5-6% target for the year. It compares to lower expectations by the International Monetary Fund (4.8%) and the World Bank (4.6%).

The government on Thursday announced that the economy grew by 5.9% in the April-June period, down from the first quarter's revised 6.3%. It was just above the median forecast in a BusinessWorld poll of analysts.

For the rest of the year, Mr. Bernardo and Ms. Gonzales said the economy should find support from the services exports, as the sector registered the highest growth at 7.6% in the three months to June.

The country's BPO firms seem to be resilient so far to global crises, they noted.

Mr. Bernardo and Ms. Gonzales , however, downgraded their 2013 growth forecast due to lingering uncertainties in the global economy.

Given the still negative outlook on global growth next year, we lower our forecast for 2013 from 5.5% to 5%, which is still an optimistic forecast that partly depends on elections and related public spending helping to drive growth, the analysts said.

The government has a 6-7% GDP growth target for next year.

Last year, the Philippines grew by a lackluster 3.9%, from a record 7.6% in 2010, due partly to government underspending.

Not quite capital control

Business World
Introspective

WITH quantitative easing and historically low interest rates in industrialized economies, and the euro zone still in a debt crisis, not a few have sounded warnings about the dangers of unstable capital flows especially to emerging markets. Monetary authorities in such economies, where interest and potential growth rates were higher, knew they would have to deal with the issue of exchange rate and asset volatility at some point.

But no matter how good one gets at anticipating the arrival of profit- seeking capital, how to actually cope with influx of hot money, which could lead to exchange rate pressure and asset bubbles, remains a tricky problem as ever. A well-known result in macroeconomics, after all, is that you can't have independent monetary policy (i.e. control over domestic interest rates), exchange rate stability, and be open to foreign capital all at once (the impossible trinity). Only two of these objectives, at most, could be reasonably met.
For the Philippines, the change in the international monetary environment, with global liquidity at an all-time high though subject to great uncertainty, seems to be changing the way the central bank is choosing to deal with dollar surges.

In the past, the Bangko Sentral ng Pilipinas (BSP) would address the problem of a rapidly appreciating domestic currency, which hurts exporters and Filipino families dependent on money sent home by overseas workers, through mostly uncontroversial measures.

Based on the belief that peso strength had fundamental basis because of high remittances and business process outsourcing receipts, these included steady accumulation of reserves, retirement of external debt, liberalization of the foreign exchange system, and strong encouragement given to the finance department to prepay the national government's dollar debt and alter the country's financing mix.
Lately, however, the BSP appears to be showing greater willingness to exercise control over the flow of capital into the country, particularly those deemed to be speculative in nature. Last October, it raised the market risk capital charge on banks' net open positions on NDFs (non- deliverable forwards), which are suspected to be a major vehicle used by offshore players to make one-way bets on the peso.

A couple of weeks ago, monetary authorities announced plans to prohibit non-residents from investing in SDAs (special deposit accounts), known to have relatively high yields and hence a natural target for carry traders especially factoring in currency appreciation. SDAs were introduced in 1998, put into greater use as a monetary tool in 2006, and opened to trust entities of banks in mid-2007, after which they have become the BSP's most potent liquidity-mopping instrument.

Not surprisingly, opinions have been mixed on the BSP's latest decision to rid SDAs of foreign-sourced funds. Some believe this may not be enough to quell speculative capital especially over an extended timeframe as ways to go around the rules are discovered, bringing little relief to dollar earners. Others find it a bit much, fearing harsher controls on capital in the future.

On the whole, the latest policy move seems reasonable, in our view. SDAs were explicitly designed to siphon excess domestic liquidity, and allowing these instruments to be the object of arbitrage play by foreign funds - their yields are not only higher than key foreign interest rates but also better than returns to Philippine government securities - defeats the stated purpose and needlessly raises the BSP's sterilization costs.
Closing offshore investors' access to SDAs corrects an evidently perverse scenario and need not be construed as capital control in the much- feared sense. It does not, for example, block the flow of productive capital and, by successfully preventing exchange rate volatility, can be easily justified.

The BSP as an institution, from our reading, remains averse to severe controls which by experience had been prone to abuse and extremely difficult to administer. Monetary policymakers continue to be wary of such measures believed to weaken long-term access to international capital markets and hinder the country's ability to attract foreign direct investments.

But can the new policy actually help prevent sharp peso appreciation?

In terms of size, SDAs seem to be a good choice of asset to purge of speculative money. One estimate places the amount of foreign funds in these accounts at about P200 billion, or close to $5 billion.

Under the new rules, these placements can no longer be renewed and will be terminated upon maturity (SDA tenors range from one week to a month), which should make at least a moderate impact on the exchange rate. We expect a sizable portion of the funds to exit the country in the interim as other peso assets do not seem to be quite as attractive in view of low yields of government securities and shrinking opportunities in Philippine equities, now with among the highest price-to-earnings ratios in the world.

On the risk of circumvention, we believe this to be fairly contained since it is perilous for banks to try to knowingly deceive the BSP with regard to compliance. The BSP is both the contracting party of the banks in the SDA placement transaction and their regulator. Based on the newly released memo on SDAs, key officials of banks and trust entities (their presidents and treasurers) will be asked to sign and submit a notarized Letter of Undertaking stating under oath their commitment not to invest funds that are directly or indirectly obtained from non-residents.

Of course, actual success of the policy remains to be seen and will depend on how far the BSP is willing to go to enforce it. At any rate, a strong signal has been sent that monetary authorities will not allow the domestic currency to strengthen by very much.

Until recently, currency traders had been vigorously betting on a stronger peso (e.g. a top pick of Morgan Stanley) in view of expected above-trend growth and current and financial account surpluses. The peso has correspondingly appreciated the most among Asian currencies this year, causing the real effective exchange rate to inch up especially against competing economies.

With tepid US growth and Europe still in a crisis, global liquidity seeking better returns could remain high. This means pressure on emerging market currencies to appreciate may continue.

Our guess is that monetary authorities have drawn a line in the sand for the peso-dollar rate somewhere near P41/$1, which seems to be a sensible number. Economists studying this area believe P40/$1 (and below) to be already quite harmful not only to OFW workers and exporters, but to the continued growth of the economy.

Romeo Bernardo is a board director of the Institute for Development and Econometric Analysis. This column is based on a July 24 report written by Margarita D. Gonzales for GlobalSource, a New York-based network of independent analysts.

Appointment to the Supreme Court

Business World
Introspective

When the administration let it be known that it would consider external nominees for a soon-to-be-vacant post in the bench, a number of us in the Foundation for Economic Freedom, an advocacy group for good governance, had the same idea of nominating one of our Fellows: the honorable Popo Lotilla. I use honorable advisedly with a small h. It is not a title (as in The Honorable Congressman Manikmanaog of TV series Abangan fame ), but a description of the man who - wherever life brings him, especially in public service - serves with honor.

Indeed this is Popo, a true public servant. How he lived and lives his life - whether as a highly esteemed professor and internationally noted legal scholar at the UP College of Law, as a very effective Undersecretary at the NEDA during the Ramos and Estrada administrations and Energy Secretary in the last one.

His reputation and experience were also the basis for his current engagement as an international public servant, Regional Director of a UN program in environment and management of the seas. The Philippine government continues to seek his expertise on UNCLOS issues, especially at this time where we are in the middle of a highly charged dispute with China. His character and commitment to the public good, as much as his track record of achievement in law, justice and development, made us think he should be considered for the post of Chief Justice of the Supreme Court.

(N.B. With honesty and simple living becoming the threshold issue for the nation, Popo has got to be the gold standard, or if you will, the foreign currency account standard. The joke going around was that the only reason he left student dormitory housing in UP campus, even when he was already working as a professional, was that they may throw him out for overstaying. He moved to a small Bliss-like faculty and staff walk-up apartment near the stud farm. This gave rise to a criticism later when he was Energy Secretary that he could not properly appreciate the problem of high cost of power because his electricity bill only came from only using one light bulb and a computer and thus qualified him for the subsidized lifeline rate.)
The nomination was made by six of us in our personal capacities - Bobby de Ocampo, Toti Chikiamco, Gloria Tan Climaco, Bong Montes, Simon Paterno and myself. We promptly received a letter response from Popo, which I though is worth sharing with the public. I will refrain from commenting on it.

As lawyers say, Res ipsa loquitur - the thing speaks for itself. And if I may add, it speaks profoundly as well of the person who wrote it.

I have considered thoroughly the nomination that you have submitted to the Judicial and Bar Council, and I can only express to you my sincere thanks, but regretfully have to decline.

In the past, I took the position that in a highly politicized context as in the Philippines, appointment to the office of the Chief Justice based on seniority is a tradition that minimizes the jockeying for appointment from within and outside of the Court. I still have to be convinced of the wisdom of departing from that view.
Without any legal compulsion behind it, this tradition was, in instances few and far between, set aside. But, time and again, its restoration has been welcomed with relief, like a lost valued symbol of character regained anew. Today, we have an opportunity to restore the tradition - or completely to overturn it. It reminds me of a story told, apocryphal perhaps, that the much venerated Justice Jose B.L. Reyes - who was older in age but less senior in tenure in the Court than the respected Roberto Concepcion - was considered for appointment as CJ to allow him to occupy the Court's highest position. J.B.L., it is said, would have none of it.

The tradition of seniority has a way of muting political ambitions and insulates to some degree the office of Chief Justice from the patronato system. Over the long term, particularly under future presidencies whose virtues we are unable to anticipate at this point, adherence to the principle of seniority may still be our best option. Restoration of the tradition, which is entirely of Philippine innovation, would then shift the national focus to the quality of every future appointment to the Court, and away from the position solely of the Chief Justice. Would not this be in better keeping with the collegial character of the Republic's Supreme Court?
I suggest that only for overwhelming reasons, such as the inability of the incumbent members of the Court to redeem themselves and the institution, should we consider appointing from outside of the Court. Whether these weighty considerations exist, the appointing power can be a better judge from the unobstructed view of the leader's lair. But my own individual assessment is colored with undisguised optimism: that the members of the Court, individually and as a collective, have distilled from recent experience lessons of primordial import for rebuilding and strengthening national institutions including the Court itself.

Wishing you all the best with a reiteration of my profound thanks,

Sincerely yours,
Popo/ Raphael P.M. Lotilla

Res ipsa loquitur.

Romeo Bernardo is a Board Director of the Institute for Development and Econometric Analysis and is Vice-Chairman of the Foundation for Economic Freedom.

Tooling our central bank

Business World
Introspective

Seasoned central bankers tend to be alert to the giant sucking sound of capital inflows that make balancing the oftentimes conflicting goals of stable inflation and output growth much harder. This policy challenge stems from the impossible trinity where in a world of mobile capital, the central bank cannot expect to remain in charge of setting interest rates if it wants stable exchange rates, without imposing capital controls.

In most discussions of this policy trilemma analysts usually ignore the impact of sterilization efforts on central bank balance sheets, i.e., of having to carry low-yielding foreign exchange assets and paying high interest on local currency liabilities. This is because central banks are not supposed to worry about how their policies, aimed at keeping confidence in the domestic currency, affect their bottom lines in the short run. In practice though, the prospect of having to explain losses to a hostile congress weighs heavily on and may even skew central bankers' policy choices.

In the case of the Philippines, when the old Central Bank failed and Congress deliberated on the new monetary authority's powers, avoiding a repeat of the massive losses was of paramount concern to lawmakers. Hence, the newly set up Bangko Sentral ng Pilipinas (BSP) was barred from pursing developmental activities and constrained from financing government deficits. Regrettably, in its zeal to avoid any loss-making functions and failing to appreciate the context to which it was used, Congress also zoomed in on central bank bills. More popularly known as Jobo bills after then Central Bank governor Jose B. Fernandez, these were issued at interest rates exceeding 40% at the height of the mid-80s crisis to restore confidence as inflation spiraled (reaching 60% at one point) and the peso plunged. And so, arguing Let the Jobo bills and all these borrowings not happen again because they caused the downfall of the present Central Bank, Congress limited its use only in cases o f extraordinary movement in the price level.

Unfortunately, this legal handicap deprived the BSP of a vital tool for mopping up excess money from the system, a problem exacerbated by its limited holdings of Treasury securities that can be used for open market operations. Hence, when money started pouring in and monetary authorities found money supply growth too high for comfort, the BSP resorted to other measures including macroprudential regulation and accepting deposits not only from banks but starting mid-2007 their trust units as well. The opening up of the Special Deposit Account (SDA) to a wider investment base siphoned off hundreds of billions of pesos from the financial system (the BSP's SDA grew more than sevenfold in 2007 from approximately P50 billion at the end of 2006).

In succeeding years, as Filipino workers' earnings grew, business process outsourcing (BPO) revenues boomed and central banks in industrial countries loosened monetary conditions in response to the global financial crisis, more and more funds rushed into an economy ill-prepared to absorb them and amounts in the BSP's SDA climbed rather steeply, reaching almost P1.7 trillion by the end of 2011.

While the BSP has seemingly managed without the power to preemptively issue its own securities, its increasing reliance on SDAs, which are nontradable and fixed-term, to drain liquidity has in fact weakened the transmission of monetary policy through credit channels. This may be seen in the divergence between 90-day Treasury bill rates, to which bank lending rates are benchmarked and policy rates, with the former falling below the latter since late 2010.

Moreover, interest rates on SDAs are at a premium over comparable tradable bills indicating that these cost the BSP more to use and hurt its profit and loss account more. At the same time, by offering higher-than- market returns, SDAs also stifle capital market development as investors can opt to move as much money as they want at the set rate into these risk- free accounts.

To be sure, SDAs have one advantage over tradable securities in a highly speculative financial environment. Since they can be accessed only by banks, their trust entities and corporates they are effective in blocking certain hot money inflows and with current interest rates in the US near zero, are less vulnerable than tradable bills to the carry trade (i.e., borrowing low-interest currencies to invest in high-interest ones). Nevertheless, to the extent that a larger part of inflows into the Philippines are of the structural kind (anchored on remittances, BPO revenues and other service receipts), it makes eminent sense to amend the law and arm the BSP with the power to issue its own paper preemptively. After all, the more tools the BSP has at its disposal (even if it may never have to use some of these), the better prepared it is to manage the complexities of today's financial world and the better able it is to calibrate its interventions to achieve specific objectives.

At the end of the day, the public and its representatives in Congress should fret less about central bank short-term losses and concentrate instead on whether it is performing its basic mandate of ensuring stable prices while at the same time delivering on other growth requisites like keeping peso volatilities to a minimum, allowing continuous capital flows especially those motivated by good macro fundamentals and outlook, and retaining policy independence to help steady the economy and the financial system in the face of global shocks.

But if Congress must keep an eye on how the central bank's financial profitability affect public sector finances, it should focus instead on the BSP long-term financial sustainability, as this is what matters for central bank financial independence and to which central bankers should be held accountable. In this regard, the national government should immediately release the long-delayed P30-billion remaining capital of the BSP and not wait for the nth hour of a crisis to act, when the BSP's credibility is at stake and the amount becomes meaningless. A bolder move would require recognizing that to a degree BSP sterilization serves a political and social purpose, i.e., maintaining a competitive exchange rate, the cost of which should be borne by the national government and explicitly accounted for in its budget. This should bring monetary policy discussions properly back to the core issues of the impossible trinity.

Romeo Bernardo is a board member of The Institute for Development and Econometric Analysis and Philippine Partner of GlobalSource. He was undersecretary of Finance during the Aquino 1 and Ramos administrations.

A tale of two taxes, two presidents

Business World
Introspective

President Aquino's leadership and resolve is at a test as he and his congressional allies are lobbied, bombarded and Noynoyed by divergent interest groups on two very live tax policy issues: a) the rollback of the VAT on oil products, and b) reform of excise taxes on cigarette and tobacco (sin taxes). Having just co-authored a case study on the political economy of the reformed VAT for the ADB, I think there are lessons in the field of tax policy reform that can be learned by the President from his predecessor and former teacher, including what not to do.

THE EXPANDED VAT - IT TOOK PRESIDENTIAL BACKING
The reform of the VAT in 2005 has been credited with reversing the alarming deterioration in fiscal numbers during the first part of the Arroyo administration and made the economy more resilient to the global financial crisis of 2008/2009. It also introduced structural reforms to the VAT system, making it more robust, broader and fairer, while plugging major leakages.

The process of getting the legislation through was not an easy one - it involved not only players in both houses of Congress and civil servants but academic institutions, development partners, business groups and civil society pushing for it, on the realization that this was the essential medicine needed at that time to forestall a fiscal crisis.

Ultimately, what made it happen though was full support of President Arroyo. After initial reluctance, she pulled all stops to get her congress and senate allies behind it. While there was a later knee-jerk attempt to back-track, after the hello Garci episode weakened her politically, the dire consequences of such flip-flopping on our the country's credit rating - and perhaps more viscerally, her own credibility - returned policy making to sobriety.

SPECIAL VAT TREATMENT FOR OIL PRODUCTS?
Fast forward to present: This 2005 VAT reform law with the desirable feature of having a broad base that was passed with great difficulty is under attack by transport groups, mass organizations, media columnists, and a few academics clamoring for special treatment of oil products. The reasons why it would be wrong to cave in were excellently argued in this space by my fellow IDEA director and Introspective columnist, UP Professor Noel de Dios (The right thing is doing nothing, March 18 ).

The crux of it is that there are no good reasons to tinker with the VAT rate for a product like oil. Moreover, similar policy, like the preferential, i.e. lower excise tax on diesel compared to gasoline, has led to wasteful distortions in consumption and production.

The recommendation of former UP professor and Planning secretary, now Monetary board member, Philip Medalla is not to tinker with the VAT system, but for the government to give rebates to jeepney operators/drivers. This is both more effective and more equitable in that it does not give tax cuts to car owners, a privileged minority in our society. Under Energy Secretary Rene Almendras' watch, this is exactly what the administration is doing.

(Lesson 1 for the current administration: Stay the course. Don't undo a good thing.)
As to how to respond to anNoynoyers? I second Prof de Dios's recommendation - Ignoy them!
SIN TAX REFORM, IT'S TIME!
There were serious shortcomings in the law amending tobacco and alcohol excise taxes passed in 1997, as a result of successful lobbying by dominant tobacco and alcohol manufactures. These flaws included - no automatic indexation mechanisms (the tax is eroded by inflation); and heavy discrimination in favor of existing dominant players.
As a consequence, the government's take from sin taxes dropped progressively over a decade, contributing importantly to its deteriorating fiscal position.

This, even as the Philippines with among the cheapest cigarettes and alcohol products tops the list of countries with high incidence of the young taking up smoking and drinking, with its attendant high social costs.

Efforts at remedial legislation to correct these flaws yielded only watered-down versions of the DoF proposals being passed. Though this can be traced again to the enormous lobbying power of the dominant players, at the heart of it, what doomed reform was lukewarm support of President Arroyo for this, a sharp contrast to her vigorous sponsorship of the VAT reform law.

(In truth, sin tax reform where potential adverse impact is concentrated on a few big players who have been experts in the game of influencing legislators has turned out to be more politically difficult than the VAT reform where the tax incidence is broadly shared by the general public.)

Fast forward to today: There is a new sin tax reform bill being deliberated in Congress that has garnered tremendous support from civil society, business groups, including former secretaries and undersecretaries of Finance and Health across administrations. The bill brings compelling benefits - it will raise revenues of about P60 billon, the bulk of which will be for universal health care, a key pillar in the government's inclusive growth agenda.

The P-Noy administration has a critical window before the next election to pass this long-delayed reform legislation and mark a game chance in being able to overcome entrenched interests that have captured Congress in the past.

(Lesson 2 from the VAT experience in 2005 - The President needs to pull all stops to get this bill passed.)
The passage of such a law may well be the acid test for credit rating agencies and investors on government's seriousness and ability to deliver on its governance and economic reform agenda. It addresses concerns over the sustainability of government's long-term fiscal position and financeability of its social and infra spending program.

An upgrade to investment grade level, where all our original ASEAN neighbors are, can unlock a virtuous circle of investments, job creation, and confidence, including for bolder reform, that can finally bring us to a higher growth path. Tuwid at maunlad na daan!

Romeo Bernardo is a board member of The Institute for Development and Econometric Analysis. He was undersecretary of Finance during the Aquino 1 and Ramos administrations.

Dragon, or drag-on?

Business World
Introspective

One would think the year 2012 should be a particularly auspicious one, as it belongs to the dragon, a symbol of might and intelligence and the only creature of myth and legend among the Chinese animal signs. But global recovery is expected to stall in the near term with the euro zone likely falling into a mild recession, and it may be just the mythical nature of the beast that would be relevant to describing economic activity in the New Year and not delivery of good fortune.

From a slow 3.7% in 2011, we expect economic growth to improve moderately to about 4.5%, though an expansion that relies on continued remittance flows and some recovery in exports will unavoidably be fragile because of intensifying risks elsewhere in the world. The steadier engine this year should instead be public spending, as the government seems fully committed to reversing the underspending that had occurred last year when it stepped up its anti-corruption drive.

Looking at purely domestic events, the impeachment proceedings against the Chief Justice offer a temporary distraction to both Houses of Congress, taking lawmakers' attention away from important economic bills. Even if the trial does drag on a bit, we do not think it presents any real political risk owing to the popularity of the current government.

ACTIVITY: FRAGILE GROWTH

While the outlook for the global economy remains bleak in the new year, we believe GDP growth of 4.5% remains achievable, though this forecast depends crucially on private consumption remaining strong, exports reviving even moderately, and government making the appropriate policy responses.

Personal consumption, which grew by 6% in 2011, appears to be supported by a number of factors - rising remittances in peso terms, declining inflation, and credit activity sustained by high liquidity. However, as we had seen in the last global crisis, private spending can, despite sustaining factors, very easily be cut as a precautionary measure by households.

There should be some revival in exports, which dropped by 3.8% in real peso terms last year, as electronics and semiconductors fell 18.5% annually. Industry experts note the technology sector may well post double- digit gains this year by simply returning to 2010 volumes, which is quite likely as inventories have already begun to decline. But like domestic spending, it is clear that this recovery also hinges on the global economy not falling into another slump.

Much depends on whether government will be able to step up to the plate to give the economy the needed boost in 2012. We are quite optimistic about a revival in public spending based on recent actions of the budget department, which has already started to frontload expenditures, particularly on infrastructure. This should help counter an expected slowdown in private activity, with the real estate cycle, which industry experts say lasts six to seven years, already starting to turn.

We are less hopeful however about the ability of the trumpeted Public- Private Partnership (PPP) program, even in its hybrid form (i.e. tapping ODA loans), to jump-start private investment owing to continued difficulties in setting up and executing well-crafted projects that fit the government's governance framework and funders' requirements.

There currently seem to be signs of stronger activity with the government's leading economic indicator index predicting expansion in the first quarter on the back of stronger tourism, stock market and new business indicators; domestic credit still expanding at a double-digit rate; and corporate earnings expected by the market to grow by over 10% this year.

All in all, while there may be higher growth in 2012 and while upside surprises may even abound, there continue to be very potent downside risks on account of the uncertainty about the future of the global economy. Given the unknowns, from moderate growth this year, we are penciling in only a mild upturn in 2013, with GDP expected to grow by about 5%.

THE PUBLIC SECTOR: WAITING FOR AN UPGRADE

The national government's budget gap likely fell below 2% of GDP in 2011 (to about 1.6% in our estimate), or some two years earlier than originally planned by economic managers. The sudden shrinkage of the national deficit traced mainly to the current administration's housecleaning efforts, particularly an overhaul of the government's disbursement procedures that led to initial delays in public spending.

With the startup hitches of good governance reforms over, we anticipate a rebound in public spending this year. Apart from base effects, this belief is bolstered by what appears to be the Budget department's determination to reverse last year's trend. Officials recently announced they have already released nearly half of the budget for 2012, while unspent funds from last year would be carried over to the present period.

This should lead to an increase in the fiscal deficit this year. However, with revenues set to continue growing through administrative efforts, the national government should be able to meet its set deficit target (2.6% of GDP).

The Bureau of Internal Revenue (BIR) performed commendably in 2011, hitting targets despite low economic growth, and will likely be able to maintain its good showing this year. The Customs bureau, in contrast, has been missing its targets (by nearly P60 billion or about 0.6% of GDP) with documented reports of wholesale oil smuggling and of several thousands of containers disappearing, hallmarks of the past administration that remain unchecked today. Clearly, intensifying the anti-corruption drive in this agency and more skilled and experienced leadership could greatly improve the government's revenue haul.

Citing fiscal improvements, the country's economic managers continue to campaign for credit upgrades, where the hope is to see Philippine debt finally gaining investment grade status. Positive developments to this end include S&P's change in outlook from stable to positive and the recent successful borrowing of the Philippine government from the long-term debt market at just 5% or better than the rate fetched by Indonesia despite the latter's newly minted investment grade rating.

We believe a change in credit ratings is likely within the year, though not yet to a lower medium grade rating. Only Fitch currently rates Philippine issues at one notch below investment grade. S&P and Moody's are at two notches below. In any case, traders typically note that Philippine sovereigns have already been trading at investment grade levels, making a credit upgrade or change in outlook basically a catch-up move.

While rating agencies recognize the country's high external liquidity and relatively steady growth, they claim to be still looking for improvements in the fiscal and debt profile, specifically in terms of a steeper downward tilt of the debt trajectory. In our own computation, without a pronounced increase in sustainable revenue sources, the near-term reduction in the public-debt-to-GDP ratio will not be enough for the country to attain levels approaching those of similarly rated peers.

Tax effort has recently also been whittled down by the implementation of several revenue-eroding laws. Unfortunately, with Congress currently very much preoccupied with the impeachment trial of the Chief Justice, we are not too optimistic, at least in the near term, that progress will be made towards passing much-needed revenue-generating legislation, e.g. reform of tobacco and alcohol taxes and fiscal incentives rationalization, that can help bring back the ratio even to recent pre-crisis levels.

This article is an excerpt from the Feb. 11 report written by Margarita Gonzales and this columnist for GlobalSource, New York based network of independent analysts. Romeo L. Bernardo is a board director of the Institute for Development and Econometric Analysis.

Build it and they will fund

Business World
Introspective

Ever since President Aquino announced his administration's PPP thrust during the first State of the Nation Address, a lot of thinking has gone into creating an infrastructure fund for the Philippines. The premise behind creating such a fund is that the domestic financial market is failing to provide the right sort of financing that infrastructure projects need, i.e., long-term (think 25 years), fixed-rate and peso-denominated. Hence, investors end up with increased risks associated with rolling over short-term debts and/or unfavorable currency movements that raise their cost of capital and ultimately increase the cost of infrastructure investments.

While the premise was defensible, it was at the same time difficult to ignore criticisms raised against it in light of overwhelming interest among private sector players to mobilize their huge sums of idle money (P1.7 trillion parked in the BSP's Special Deposit Account) for infrastructure investments as well as the overtures of development partners pledging financial support of varying maturity, interest and currency profiles.

Moreover, the design and structure of the national government-driven proposed fund, which was envisioned to be catalytic yet commercially oriented, fell short of capturing the full support of either government or international financial institutions tapped to contribute to it. Many of these privately voiced the view that they can generate superior returns by directly investing in projects of their own choosing rather than in a pooled fund to be managed by a new, untested institution. Thus, despite much ado, the infrastructure fund to date remains on the drawing board.

While the nationally directed infrastructure fund continues to undergo tweaking, one of the chosen funders, the public pension fund Government Service Insurance System (GSIS), has announced a plan to create its own infrastructure fund. Unlike earlier versions with their confusing mandates of balancing developmental and commercial objectives, the GSIS-led fund is designed primarily to meet GSIS goals, i.e., diversification of fund assets, better matching of assets and liabilities as well as potentially higher returns.

Indeed, pension funds around the world have increasingly been attracted to infrastructure assets on the assumption and some evidence that these assets have a risk-return profile falling in between bonds and equities, i.e., they offer higher risk/returns vs. bonds while lower risk/returns vs. equity investments. Hence, from mere buying of listed stocks of companies in the infrastructure sector, pension funds have, depending on their individual risk appetite (which is also a function of their demographic profiles), moved into investing in listed or unlisted infrastructure funds managed by third parties, buying portions of infrastructure assets directly, or in the case of one Canadian pension fund, setting up an investment arm dedicated to finding suitable infrastructure assets. Many have opted to invest not only domestically but internationally. Increasingly too, pension funds are not only looking at mature assets with stable cash flows but a recent The Economist article (from which the title of this piece is borrowed) reported on a plan in the UK for pensions to invest in higher-risk greenfield assets.

This appears to be the thinking behind the GSIS infrastructure fund as well. In light of the Aquino administration's ongoing efforts to develop a pipeline of PPP projects, there are significant opportunities for an entity that takes a long view of investment returns to participate in the program. More so if the entity is well-placed to handle political and regulatory risks that investors typically associate with infrastructure projects in the Philippines.

News reports reveal that the initiative for the infrastructure fund is being pursued by GSIS with the Asian Development Bank and International Finance Corp., the private sector arm of the World Bank, as cosponsors (Infrastructure fund eyed, BusinessWorld, Nov. 16, 2011). This brings international professional expertise in finance and the highest degree of governance in its management, and insulates it from harmful political interventions beyond the term of this administration, a clear commitment to structural reform of a lasting nature which deserves public commendation. Moreover, it is expected that fund management will be outsourced to professional infrastructure experts with global track record which will help ensure that investment decisions are anchored on arms-length, transparent and non-political criteria and processes.

On the face of it, investing in infrastructure is a wise move for GSIS which needs to diversify its investment portfolio. The pension fund, with an asset base of about P600 billion (7% of GDP) has limited investment options. Based on its 2009 financial statements, over three-fourths of its investments was equally divided in only two asset types - government securities and loans, largely to members (and this was at a time when a portion of its portfolio was still invested overseas). Given its size, forays into the relatively small and illiquid local stock market through direct share purchases had tended to attract governance-related controversies. Likewise, the attempt to diversify its portfolio internationally in 2008 was short-lived as it coincided with the global financial crisis. The funds were redeemed last year and invested locally.

Such a diversification move is also in line with the recommendations of an international team of consultants commissioned by the World Bank and the Department of Finance that included pension gurus Estelle James and Alberto Musalem. Filipino actuary Ernie Reyes, financial analyst Christine Tang and I were privileged to join that team. Our 200-page report, Structural and governance reform of the Philippine pension system, 2007 had this to say on the need for diversification:

Diversification of portfolios is a significant issue for each institution (referring to GSIS, SSS, et al.). A basic problem is the diversification of investments within the relatively few opportunities offered by the local financial markets (both commercial and government securities). Pension related institutions already play a substantial role in the Philippines' capital market, with a capacity to move market prices. Part of the problem is that pension institutions tend to hold and manage stocks in individual companies, so even if their share in the overall stock market is not so great, they are able to move market prices for specific companies. Greater diversification domestically, and investing through pooled instruments would reduce the impact of investment by these institutions on price movements.

Romeo L. Bernardo is managing director of Lazaro Bernardo Tiu & Associates, Inc., Philippine advisor of GlobalSource, and a board member of the Institute for Development and Econometric Analysis, Inc.

Build it and they will fund

Business World
Introspective


Ever since President Aquino announced his administration's PPP thrust during the first State of the Nation Address, a lot of thinking has gone into creating an infrastructure fund for the Philippines. The premise behind creating such a fund is that the domestic financial market is failing to provide the right sort of financing that infrastructure projects need, i.e., long-term (think 25 years), fixed-rate and peso-denominated. Hence, investors end up with increased risks associated with rolling over short-term debts and/or unfavorable currency movements that raise their cost of capital and ultimately increase the cost of infrastructure investments.

While the premise was defensible, it was at the same time difficult to ignore criticisms raised against it in light of overwhelming interest among private sector players to mobilize their huge sums of idle money (P1.7 trillion parked in the BSP's Special Deposit Account) for infrastructure investments as well as the overtures of development partners pledging financial support of varying maturity, interest and currency profiles.

Moreover, the design and structure of the national government-driven proposed fund, which was envisioned to be catalytic yet commercially oriented, fell short of capturing the full support of either government or international financial institutions tapped to contribute to it. Many of these privately voiced the view that they can generate superior returns by directly investing in projects of their own choosing rather than in a pooled fund to be managed by a new, untested institution. Thus, despite much ado, the infrastructure fund to date remains on the drawing board.

While the nationally directed infrastructure fund continues to undergo tweaking, one of the chosen funders, the public pension fund Government Service Insurance System (GSIS), has announced a plan to create its own infrastructure fund. Unlike earlier versions with their confusing mandates of balancing developmental and commercial objectives, the GSIS-led fund is designed primarily to meet GSIS goals, i.e., diversification of fund assets, better matching of assets and liabilities as well as potentially higher returns.

Indeed, pension funds around the world have increasingly been attracted to infrastructure assets on the assumption and some evidence that these assets have a risk-return profile falling in between bonds and equities, i.e., they offer higher risk/returns vs. bonds while lower risk/returns vs. equity investments. Hence, from mere buying of listed stocks of companies in the infrastructure sector, pension funds have, depending on their individual risk appetite (which is also a function of their demographic profiles), moved into investing in listed or unlisted infrastructure funds managed by third parties, buying portions of infrastructure assets directly, or in the case of one Canadian pension fund, setting up an investment arm dedicated to finding suitable infrastructure assets. Many have opted to invest not only domestically but internationally. Increasingly too, pension funds are not only looking at mature assets with stable cash flows but a recent The Economist article (from which the title of this piece is borrowed) reported on a plan in the UK for pensions to invest in higher-risk greenfield assets.

This appears to be the thinking behind the GSIS infrastructure fund as well. In light of the Aquino administration's ongoing efforts to develop a pipeline of PPP projects, there are significant opportunities for an entity that takes a long view of investment returns to participate in the program. More so if the entity is well-placed to handle political and regulatory risks that investors typically associate with infrastructure projects in the Philippines.

News reports reveal that the initiative for the infrastructure fund is being pursued by GSIS with the Asian Development Bank and International Finance Corp., the private sector arm of the World Bank, as cosponsors (Infrastructure fund eyed, BusinessWorld, Nov. 16, 2011). This brings international professional expertise in finance and the highest degree of governance in its management, and insulates it from harmful political interventions beyond the term of this administration, a clear commitment to structural reform of a lasting nature which deserves public commendation. Moreover, it is expected that fund management will be outsourced to professional infrastructure experts with global track record which will help ensure that investment decisions are anchored on arms-length, transparent and non-political criteria and processes.

On the face of it, investing in infrastructure is a wise move for GSIS which needs to diversify its investment portfolio. The pension fund, with an asset base of about P600 billion (7% of GDP) has limited investment options. Based on its 2009 financial statements, over three-fourths of its investments was equally divided in only two asset types - government securities and loans, largely to members (and this was at a time when a portion of its portfolio was still invested overseas). Given its size, forays into the relatively small and illiquid local stock market through direct share purchases had tended to attract governance-related controversies. Likewise, the attempt to diversify its portfolio internationally in 2008 was short-lived as it coincided with the global financial crisis. The funds were redeemed last year and invested locally.

Such a diversification move is also in line with the recommendations of an international team of consultants commissioned by the World Bank and the Department of Finance that included pension gurus Estelle James and Alberto Musalem. Filipino actuary Ernie Reyes, financial analyst Christine Tang and I were privileged to join that team. Our 200-page report, Structural and governance reform of the Philippine pension system, 2007 had this to say on the need for diversification:

Diversification of portfolios is a significant issue for each institution (referring to GSIS, SSS, et al.). A basic problem is the diversification of investments within the relatively few opportunities offered by the local financial markets (both commercial and government securities). Pension related institutions already play a substantial role in the Philippines' capital market, with a capacity to move market prices. Part of the problem is that pension institutions tend to hold and manage stocks in individual companies, so even if their share in the overall stock market is not so great, they are able to move market prices for specific companies. Greater diversification domestically, and investing through pooled instruments would reduce the impact of investment by these institutions on price movements.

Romeo L. Bernardo is managing director of Lazaro Bernardo Tiu & Associates, Inc., Philippine advisor of GlobalSource, and a board member of the Institute for Development and Econometric Analysis, Inc.