‘Trying times’ to weigh on growth

BUSINESS WORLD

Posted on November 17, 2013 10:12:25 PM

By Bettina Faye V. Roc, Reporter

PHILIPPINE economic growth will remain strong, a New York-based consultancy said, but may slow in the long run as the government deals with policy and economic challenges.

The Aquino administration is in the middle of "trying times," GlobalSource Partners said in an outlook released last week, with its reform agenda at risk of being derailed by ongoing political issues as well as a series of natural disasters.

"Since late July, the nation’s leader has had to face down an armed conflict in the south, deal with public anger over the theft of public funds and the pork barrel system, counter questions about the legality of his own budget juggling and cope with a series of natural disasters, including the massive devastation wrought by super storm Haiyan (local name: Yolanda)," GlobalSource’s local partners, Romeo L. Bernardo and Marie-Christine Tang, said in the report.

"For now, we expect growth to stay above trend in the short term but think that maintaining the current high consumer and business optimism may become more challenging, a risk to sustaining high economic growth further out," the economists added.

GlobalSource’s gross domestic product (GDP) growth forecasts for 2013 and 2014 are 7.2% and 6.2%, respectively. The Philippines grew by 6.8% last year, exceeding the government’s 5-6% target.

First-half growth reached 7.6% this year, also well above the government’s 6-7% goal. Next year, growth is targeted to reach 6.5-7.5%.

Mr. Bernardo and Ms. Tang said the "festering scandal" involving the alleged misuse of legislators’ Priority Development Assistance Funds (PDAF), which has since evolved to include the reported unconstitutionality of the government’s Disbursement Acceleration Program (DAP), could sidetrack reforms.

"To be sure, the economy still has momentum going for it and is shielded to some extent from the political mayhem as remittance and BPO (business process outsourcing)-driven consumption growth can be expected to keep it chugging along as before," they said.

"Thus ... economic growth remains likely to continue, albeit below par."

The fund misuse issue could prove to be a roadblock for the government’s legislative agenda given Congress’ involvement, the economists warned. Likewise, as the scandal involves the use of public funds, the government may become more cautious in spending, raising the risk of unmet targets.

"The confusion over PDAF and DAP and their legalities appeared to have led to greater caution in fund releases, which may help explain the marked drop in government spending since August, compounding worries about underspending for this year and even next," the economists said.

"While falling below midyear deficit targets is not new for this administration, it had previously resorted to the DAP to catch up on spending by using unspent funds for other programs ... This time, even though typhoon relief and rehabilitation operations have created demand for legitimate spending ... we are unsure how aggressively the administration can use the DAP to catch up on spending."

The bigger concern, they noted, involves how planned changes in the budgetary process will affect fund releases.

"It may well be that this new system will minimize the risk of fraud and lead to greater confidence on the part of officials tasked to sign off on disbursements. But based on what happened when the administration first took over, a new system also risks a J-curve effect, where spending will first fall as new rules are internalized and kinks smoothened out," the economists said.

The devastation caused by super typhoon Yolanda, which battered the central Philippines last Nov. 8, will also be another test for the administration and a risk to business and consumer optimism.

"How the President handles the tragedy ... with millions of lives at stake and the world watching closely, can also spell the difference between his ability to continue governing effectively or losing credibility and becoming a feckless and increasingly lame-duck president," they declared in the report.

While the full economic impact of the devastation caused remains unknown, they said it would likely not cause growth to fall below trend, especially with government and aid-financed reconstruction activities helping to offset any contraction in affected areas.

"Indeed, while we had initially considered a downward adjustment in our growth forecasts due in part to what we thought was the government’s reduced confidence and budget flexibility to pursue catch-up spending, we now think that relief and reconstruction efforts in the Visayas will help make up for a portion of the shortfall," GlobalSource’s Mr. Bernardo and Ms. Tang said.

http://www.bworldonline.com/content.php?section=TopStory&title=%E2%80%98Trying-times%E2%80%99-to-weigh-on-growth&id=79513

Tragedy as opportunity

BUSINESS WORLDIntrospective

I HAVE just listened to Bank of the Philippine Islands (BPI) President Cezar Consing speak before the 51st Annual Meeting of the Philippine Economics Society. Far from the dry financial statistics-filled presentation expected of a banker addressing economists, he gave a stirring talk on how this national crisis can serve as an opportunity. I am pleased to share his remarks:

"So if the macro numbers can withstand Yolanda, what should we as economists be worried about? One only need watch the tragedy unfold on television, and be aware of our own gut response to what we see and hear, to know the answer. Our affected countrymen’s desperate search for food, water and medical supplies, the throng of people in the airport looking for a way out of Tacloban, the looting of public establishments, the almost complete absence of public utilities, is threatening to destroy the growing confidence that we as a people had begun to feel -- a result of the newly earned investment grade rating, the national government’s campaign against graft and corruption, and the exploits of Manny Pacquiao, Gilas Pilipinas, the Askals and Megan Young.

"As a banker, I keep an eye on two macro numbers. First, is our GDP per capita. I note that at $2,600 it is about a quarter of the average GDP per capita of countries with credit ratings equal to ours. Second, is our ratio of bank loans to GDP. I note that it is somewhere between 35% to 40%, about the same as Indonesia, but half of India’s and certainly much lower than most of the more developed Asian countries that have bank debt to GDP ratios well in excess of 100%. 
Amen!



"Two years ago, BPI Foundation, working in partnership with WWF (World Wildlife Fund) -Philippines, commissioned a project called the Climate Risk Adaptation Project to study the effects on key cities of extreme climate events. The study, completed in late 2011 but yet to be released, has proven to be remarkably prescient. The calamity that has befallen Tacloban proves that sometimes the academics get it right.

"So what does the tragedy that is Tacloban have to do with sustainable and inclusive growth? Everything I am afraid.

"Our country has demonstrated its ability to weather global economic storms -- note the 1998 Asian crisis, the 2008 Lehman crisis, and the 2013 Emerging Markets volatility brought about by the prospect of tapering. But I wonder whether we will be able to as successfully weather the crisis brought about by bad weather.

"Surely, from the standpoint of macroeconomic performance, the tragedy in Eastern Visayas is manageable. The region accounts for only 2% of GDP. With the budget deficit at only 2.3% of GDP, the government has the wherewithal to step up spending. In fact, while Secretary Purisima has indicated that the GDP growth rate in 2014 can be reduced by 1% as a result of the calamity, our economists in the bank think that 6.5% to 7% growth in 2014 is still very achievable. Even Yolanda’s inflation impact should be muted. Eastern 
Visayas accounts for only 3.5% of sugarcane production, and the rice reportedly lost is less than a hundredth of the country’s total annual production, principally because most of the rice had already been harvested. Finally, and ironically, rebuilding efforts should provide a GDP boost in 2014.

"If there is one theme underlying the haunting post-typhoon images of Tacloban, it is the severe lack of, or shortcomings in, public goods in all its forms -- power, water, roads, bridges, airports, hospitals, military transport vehicles. In fact, we should probably marvel at what has been accomplished in the aftermath of the typhoon despite the dearth of public goods, and for this the private sector deserves much kudos.

"As all of us intuitively understand, sustainable growth requires an ample supply of public goods. There are limits to privatization. Indeed, if profits were the sole objective of economic behavior, very little by way of public goods would be supplied. But provide a strong base of public goods, and the private sector will follow the money to provide the "oomph" that every healthy economy needs.

"Inclusive growth is probably even more dependent on public goods. The poor have less ability to pay as they go. A good baseline of public goods does more to improve the relative situation of the poorest amongst us than the richest amongst us. Indeed, the countries with the best public infrastructures tend to be the most economically inclusive.

"Tacloban has highlighted the importance of public goods, of hard and soft infrastructure, much more vividly than any economics textbook ever can. Tacloban is frightening because it could be any place in our beloved country. Tacloban is depressing because it reveals a chink in our armor, and rips away at our growing confidence that, as a nation, we are about to join the more developed countries in the region. Tacloban is infuriating because, by bringing to the fore the dearth of public infrastructure, it exemplifies the true cost of graft, corruption, and tax evasion.
"So having spent several minutes bemoaning our fate, what can we do to be constructive?

The conclusion one draws by looking at these two numbers is pretty straightforward. That is, as a country we are still quite poor and, as a result, most of our countrymen are not creditworthy by conventional banking standards. Indeed, 80% of Filipinos are still unbanked.

But if we as a people become a little more prosperous, if we can achieve a per capita income closer to, say, $4,000, a much larger percentage of us become bankable. This per capita target is achievable if we continue to grow at, say, 7% or more per annum and control our procreative impulses. And how do we sustain this growth rate? Given our growth trajectory, the answer must be infrastructure. Indeed, many economists cite infrastructure bottlenecks as potentially slowing down our current pace of growth.

"So it is our bank’s objective to participate in the PPPs (Public-Private Partnerships), assuming they can be structured and governed to justify the significant level of resources that must be allocated to almost every project. This caveat is critical and reveals the limitation of private sector infrastructure financing. There is no escaping the need for an appropriate financial return on private capital. Indeed, the private sector is a poor supplier of true public goods. These only the government can supply.

"Tacloban need not be an absolute disaster, its handling need not be a national shame. Tacloban need not derail our growing confidence that our country’s economic prosperity is attainable in our lifetimes. But if we are to regain our mojo, we must step up. Government must do more to provide the public goods that will be supportive of sustainable and inclusive economic growth. As a people, we have to learn to accept, and in fact champion, rigorous, unflinching campaigns to curb tax evasion, graft and corruption, and administrative incompetence, for how else can we afford what we have to afford? As banks, we have to get bigger, since only by getting bigger can we be truly supportive of the long term capital formation needs of our nation. If we can find it in ourselves to each do our part, we can use this tragedy, one of Biblical proportions, to step up as Filipinos, in firm control of what we can control, and on the path of sustainable and inclusive growth."

(Romeo Bernardo sits as board director of the Institute of Development and Econometric Analysis, Inc. and the Bank of the Philippine Islands.)

Political Economy of Reform During the Ramos Administration 1992-1998

World Bank Growth Commission Working Paper 39
By
Romeo L. Bernardo and Christine Tang

http://siteresources.worldbank.org/EXTPREMNET/Resources/489960-1338997241035/Growth_Commission_Working_Paper_39_Philippines_Case_Study_Political_Economy_Reform_During_Ramos_Administration_1992_1998.pdf

Being water secure

Business World, Introspective

WATER SECURITY is ensured only when long-term investment and financing for the sector are sustainably and efficiently done to meet the needs of a growing population, the economy and the environment. This was the clear message delivered at a recent forum on Water Security organized by Finex.

IFC Resident Representative Jesse Ang said in the forum that while the Philippines is not yet considered a water-scarce country, management of the resource needs to be strengthened. While former MWSS Chairman Dondi Alikpala concurred that there is no water deficit yet, former MWSS Administrator Dr. Lito Lazaro explained why: “With the improved efficiency of both Manila Water and Maynilad in reducing previously big leakages (non-revenue water) the gain to Metro Manila is almost like building a new huge dam.”

Dr. Lazaro was too modest to discuss the benefits reaped over 16 years of the highly successful “largest water privatization” in the world: the broad public welfare gains, not just in water security, but in environmental protection, health, and outreach to poor communities. In short, clean water made available to Mang Juan. As CEO of MWSS, he was one of the three architects, under the direction of President Ramos, who made this privatization happen. The other two were then DPWH Secretary and MWSS Chairman Virgilio Vigilar, and Mark Dumol, the Secretary’s Chief of Staff. I was a member of the MWSS Board as Finance Secretary Bobby de Ocampo’s representative, and consider myself fortunate to have had a big front view and a small role.

The success story of this privatization is objectively and engagingly told in a book Built on Dreams, Grounded in Reality (http://asiafoundation.org/resources/pdfs/Chapter4.pdf) by former UP School of Economics Dean and our only living National Scientist in Economics, Dr. Raul Fabella. Chapter 4, “The Privatization of MWSS: How and Why It Was Won” had this to say:

“The privatization of MWSS was clearly a triumph of the principle of comparative competence-the private sector proved more competent at the delivery of water and sewage services than the state. It is now considered a singularly successful structural reform in the annals of Philippine political economy.”

The welfare gains for the public is a matter of public record. In the Joint Statement on Water Public Private Partnership (PPP), the Foundation for Economic Freedom, the Management Association of the Philippines, the Employers Confederation of the Philippines, and Philippine Chamber of Commerce and Industries noted that the water PPP has “contributed much to improve public welfare by having more than doubled the number of customers served, provided 24 hour water service availability that meets health standards, while addressing the needs of millions in the poor communities. The improvements in service delivery came after the two concessionaires poured in a combined P105 billion in investments to expand and upgrade the water and sewage network, achieved without adding to government’s fiscal burden or public debt exposure.” They further lamented that it’s a pity that this “successful, internationally recognized model PPP has not been replicated outside Metro Manila where the water situation remains at pre-privatization MWSS standards”.

It is disturbing indeed that instead of building on this success and nurturing the greater water security achieved over the years, we now observe populist myopic demands, not just by the usual suspects from the protest industry, but by MWSS itself, for arbitrary reductions in water rates -- already the lowest in the country, and compare favorably internationally. This will inevitably compromise water security over the medium and long term as needed investments for maintaining service quality and protecting the environment are neglected.

The Japanese Chamber of Commerce and Industry was quite emphatic in this regard: “We view the MWSS’ unilateral and arbitrary act of changing the terms or interpretation of the concession agreement, in total disregard of the contractual rights and intent of the parties, with grave concern.” Such unilateral populist action by government agents is referred to in regulatory economics literature as “administrative expropriation,” a form of “government opportunism” inflicted on captive investors in utilities. (See e.g. Spiller and Tommasi, pp 515-543, Handbook of New Institutional Economics, Menard and Shirley, eds. 2005. )

There are a number of issues in the dispute notices that the two concessionaires submitted for international arbitration, ranging from the computation of the appropriate discount rate (allowed rate of return) to the disallowances pertaining to past and future investments, and incredibly, a reinterpretation 16 years hence, of treatment of corporate income taxes. As these are in the realm of a legal process, it is best to refrain from discussing these. One trusts that as had happened in the previous two arbitrations, all parties will abide by the final decision of the Panels, and move on from there to follow in good faith, the letter and spirit of the Concession Agreements.

The one item of contention that calls for comment is on who is responsible for investing in new raw water sources -- an key element to water security. The insistence of the current MWSS management that investments in such are excluded under the Concession Agreements, and therefore disallowed in the tariff rate setting, squarely contradict the intent of the Agreements. More fundamentally, given MWSS, and government’s, dismal track record in public service provision -- especially when contrasted with the two concessionaires’ -- such revisionist interpretation will certainly bring us back to pre-privatization water insecurity.

Mark Dumol, in a letter reproduced in the widely read column of Boo Chanco (“Did P-Noy accept excuses for infra lag?”, Philippine Star, June 26, 2013) was categorical on what they had in mind: “Without any doubt, the original intent of the MWSS concession agreement was that all aspects of the provision of potable water, from raw water sourcing to treatment to distribution would be the responsibility of the concessionaires.”

I also consulted Dr. Lito Lazaro on this and he said “in my mind it was clear that raw water development is the responsibility of the concessionaires. How can the concessionaires be held to their targets if they are not responsible for the raw water development, since complying with the targets assumes that water is available?”

I asked Dr. Lazaro why the Concession Agreements were not absolutely explicit in its provisions on this. He said the “main reason for this is that there were unsolicited proposals pending with the MWSS on most of these water sources” that there was need to protect the Agreements from legal challenges from such proponents claiming vested rights under the BOT law. In fact one such proponent filed a TRO to stop the MWSS privatization bidding; thankfully, it was thrown out by the courts.

This unilateral reinterpretation by MWSS, which now risks all the gains achieved in one and half decades, had Mark Dumol wondering: “Why has the MWSS voluntarily decided to take on this obligation which would require it to seek huge financing, hire a lot of staff for a Project Management Office, design and bid out the projects and then deal with big contractors and consultants? One can only guess why.”

Why indeed.

Romeo Bernardo was Finance undersecretary during the Aquino 1 and Ramos administrations, and board director of Institute of Development and Econometric Analysis, Inc.

Differentiated

THE BETTER-THAN-EXPECTED 7.5% 2Q13 growth certainly brought cheer to local stocks battered by two weeks of bad news. The main stock index rose a cumulative 6.0% in the past two days following the announcement last August 29 that the local economy bested other Southeast Asian countries where growth ranged from 2.8% (Thailand) to 5.8% (Indonesia) during the period.

Several foreign analysts have announced upward adjustments to their growth forecasts, bringing their full year numbers closer to our earlier forecast of 7.2%. The local economy’s resilience in the face of external turbulence reinforces our view that the Philippines is somewhat differentiated from its peers not only by having a structural current account surplus, fueled by remittances and BPO earnings, but also by having local growth drivers, mainly public spending and private investments, to lean on. The latter may be traced to local economic authorities’ ability to pursue accommodative policies given a benign inflation outlook and manageable public debt.

While we are keeping our 2013 GDP forecast for now, we anticipate the pace of growth to fall below 7% starting this quarter. This is due primarily to the disappearance of election-related stimulus and its impact on government and household spending. Moreover based on the just released numbers, we see some downside risks, including:

(a) Decelerating year-on-year consumption growth over the past four quarters. It is hard to tell at this time if the peso depreciation’s boost to incomes from dollar remittances can reverse the trend;

(b) Likely more timid spending by the government moving forward in the wake of the still-unfolding major multibillion pork barrel scandal;

(c) Dampened investor confidence due to recent financial market developments. 2Q13 data already reflect a significant slowdown in private construction -- from over 20% real growth since 3Q12 to just 9% last quarter -- and the BSP Business Expectations Survey, released August 30, reveals a less-upbeat mood for 3Q13. Expected increases in borrowing costs due to withdrawal of liquidity from emerging markets may dampen moods further;

(d) Weakness in imports, including of inputs to electronics goods, makes a convincing export recovery story still elusive, despite improving growth indicators in the US and China. The country’s export promise has in recent years switched to the BPO sector, which continues to show growth. In 2012, on a 30% value-added rule of thumb, the electronics sector pulled in $6 billion, about half of the $11.6-billion haul of BPO services.


2014 AND BEYOND

Will the country sustain the 7% growth trajectory in 2014 and next? Given the disappearance of one-offs (elections) in the near future and maturing business cycle, it is highly doubtful to maintain such feat. Moreover, recent delays in infrastructure projects may further derail the economy on its high growth track. On our part, we see above-trend growth for 2014 (6.2%), still outpacing other emerging markets, because healthy macroeconomic fundamentals and consumption will likely underpin growth in the future.

While our forecasts are a shade higher than the consensus, we share the view that growth will decelerate over time. The main reason is that despite being encouraged by optimism, we think that other than in real estate which analysts, including ourselves, estimate to be in it seven-year mid cycle, private investments particularly FDI will realistically be more modest than what the government is hoping for. To be sure, investors are trooping into town and the high registration numbers recorded in the country’s economic zones since 2010 reveal genuine intent to set-up shops locally. However, these plans will take time to complete and actual inflows as reflected in FDI numbers have yet to impress. Moreover, we are told that business park locators are starting to look into possible problems associated with the industrial zones’ absorptive capacity, not only in terms of space limitations but also congestion due to inadequate supporting infrastructure, notably in transport, ports and power. For instance, the energy secretary has warned that if growth stays on its current path, the Luzon grid would face supply tightness in 2015 particularly in the summer months.

Meanwhile, infrastructure PPPs continue to face delays, with bidding failures and push out of bidding schedules. In our view, this is due to, among others, over-cautiousness and underpricing of opportunity cost of delays at top level/s, lack of technical capability of implementing agencies, and misallocation of risks between government and the private sector. One example of the last is on risks arising from potential new local real property taxes on rail or airport assets. These are risks that should be born by government, based both on logic of efficient risk allocation (party that can best bear/manage the risk should carry it ) and on past experience where power and rail assets became the object of such form of “hostage taking” by local governments units. Surprisingly, the draft contracts for bidding load such risk on the bidders; unsurprisingly, no shows and further delays.

In another instance, perceptions of regulatory risks were heightened by recent populist public bashing by the agency-in-charge, echoed by a chorus of legislators, of a highly successful 15 year internationally recognized water PPP for Metro Manila. This became the subject of a statement of concern by four national business organizations, and is now inexorably headed for international arbitration.

With investors expected to increasingly fret about the outcome of the 2016 presidential elections, economic growth further out would depend in our view on government’s ability to crystallize a convincing follow-on story in support of the investment grade rating that investors can anchor their decisions on. This is emerging to be a truly challenging task in the current external environment and local political landscape. The latter is complicated by a serious “pork barrel” scandal, and the accompanying public disaffection and government distraction, with no clear closure in sight.

http://www.bworldonline.com/content.php?section=Opinion&title=Differentiated&id=76140



Part of this column came from GlobalSource reports entitled “Differentiated” (August 30, 2013) and “In a Good Place” (August 8, 2013), both written by Christine Tang and the columnist. Romeo Bernardo is a board director of IDEA. He served as Undersecretary of Finance during the Aquino 1 and Ramos administrations.

Water now and for tomorrow

Introspective, Business World
Posted on June 30, 2013 08:21:53 PM

THERE HAVE recently been emotional calls in media and in the streets for reduction in water tariffs, much somewhat disconnected from considerations of quality of service and investments needed to maintain standards. I feel it useful to revisit a column I wrote in Jan. 2011, "A PPP Success Story," that goes back to why PPP was adopted to solve what was rightfully called a "water crisis" (http://romeobernardo.blogspot.com/2011/01/a-ppp-success-story-business-world.html).

Let me start with some disclosures. I had sat on the MWSS Board back in the 1990s as Finance undersecretary when work on its privatization started. I have keenly kept tabs of developments in the "largest water privatization in the world" since then and became very familiar with the regulatory regime as an advisor of one of the concessionaires, Manila Water. I am also a consumer, sharing a desire to pay the least for the best.

Readers of my past column know that I am greatly impressed by how water services have improved tremendously since my days in the government. Manila Water’s early achievements in slashing non-revenue water, raising water deliveries by over 2.5x, doubling the number of customers and at a 24-hour water availability service level are, most importantly, meeting health standards which I understand is being replicated in the west zone since the entry of Metro Pacific in late 2006.

In a span of six years to 2012, Maynilad has also reclaimed 600 mld of water by reducing non-revenue water from 66% to 43%, raising volume of water deliveries from 629 to 1,200 mld, and serving eight million customers (from six million) with 24/7 water availability, including some 1.7 million in poor communities.

The improvements in service delivery came after the two concessionaires poured in a combined ₱105 billion in investments (₱60 billion for Manila Water from 1997 to 2012 and ₱45 billion for Maynilad under MPIC) to expand and upgrade the water and sewerage network. Judging from the state of the country’s other infrastructure, including water facilities in other major cities in the country, government would never have had the resources to make similar investments, on the aggregate equivalent to 1% of last year’s GDP, for water distribution.

Unfortunately, this important detail is often lost in the emotionally charged debate on water tariffs, with some sectors even considering the mere fact that tariffs have been rising since 1997 the singular proof of the failure of privatization. Granted that the annual growth rate in water tariffs post privatization may seem high, the evolution of water rates needs to be assessed not only against the above investments to expand and upgrade the system but also their historical and forward-planning contexts.

Two historical facts stand out. A well-known "twin" event is the almost immediate shock to debt servicing cost of the two concessionaires due to the Asian financial crisis in 1997 followed the next year by a shock to revenues due to a severe El Niño drought. Both were extraordinary events that could not have been anticipated in the concessionaire bids and thus, led to unexpected, extraordinary adjustments in water tariffs.

The second, less well-understood historical fact is the design of the privatization contest where the winning bidders were chosen based on lowest submitted tariff. Understandably, the objective at the time of the reformers was to secure broad-based buy-in for water privatization by asking consumers to pay less. Some would say that the resulting bids, at deep discounts to then existing rates, planted the seeds of "high" water tariffs today. Had the contest been designed based on highest concession fee, similar to what was done for the NAIA Expressway, the initial tariff rate would likely have stayed at ₱8.78/m³ (not ₱2.32/m³ for the east zone and ₱4.97/m³ for the west) and government would have received a windfall from the winning bidders.

But perhaps the key inputs to understanding the more recent evolution of water tariffs are the size, timing and nature of investments needed to meet service targets that can keep customers satisfied. Contrasting utility services (water, electricity, telephone) during typhoon Milenyo, UP professor and Inquirer columnist Randy David, a Manila Water customer, explained the uninterrupted water service as likely arising from a service culture that is based on "anticipation of possible disruptions, adequate preparation for emergencies, regular maintenance of the delivery system, a continuity team that is activated in times of disaster, and provision of substitute services during prolonged interruptions of regular service ("Public Lives: Decency and public utility firms," PDI, Oct. 15, 2006)".

The mandate to cover the entire concession area requires the concessionaires not only to provide the above service quality to existing customers but to undertake expansion plans (a) with future population growth in mind and (b) involving more difficult terrains in less populated areas, as well as (c) invest in less tangible and thus, less appreciated sanitation and sewerage services that have health and environmental benefits beyond the confines of the concession area. By the nature of a network service, all this would have to be borne by existing customers even if they do not directly benefit from expansion of piped water services to hilly Antipolo.

At the end of day, the water bill of Metro Manila residents, amounting to an average 3% of household income, remains within international standards of affordability, i.e., 5% of income. One also cannot ignore statistics showing that despite the massive capital infusion and superior operational metrics (24-hour water availability, low NRW, etc.), the two concessionaire’s water charges are also among the lowest in major cities in the country. For example, a 30-m³ consumer in the east zone is billed ₱458 for his water consumption compared with same volume water bills in Metro Cebu (₱463), Iloilo (₱509) or Baguio (₱1,137). The differences are even starker for those consuming up to 10 m³  even while the service quality in these areas are more like those of pre- privatization MWSS.

Note too that Manila Water rates compare well also versus other Asian cities. Based on a 15-m³ consumption, Manila Water dollar rate (0.26/m³) falls in the middle of Jakarta (0.59), Beijing (0.47) Bangkok (0.27), New Delhi (0.19), Hanoi (0.19), Kuala Lumpur (0.18) and Phnom Penh (0.16). Few of these have achieved close to the performance standards of Manila Water -- the reason the company has received mandates to run and introduce the same kind of improvements in three of these countries in collaboration with local partners. MWC has received prestigious international awards for providing for the urban poor, environmental sustainability and for operating efficiency from The World Economic Forum, INSEAD, IFC/World Bank, and the International Water Association. It has also been written up as a case study of a successful reform undertaking by the Harvard Business School, the International Finance Corporation, the World Bank Growth Commission and others.

One particularly noteworthy work was penned in 2011 by former UP School of Economics Dean Raul Fabella, also our only living National Scientist in Economics with whom I am honored to share this "Introspective" column space as a fellow Trustee of IDEA. His Chapter 4, "The Privatization of the Metropolitan Waterworks and Sewerage System: How and Why It Was Won," in the book "Built on Dream, Grounded on Reality"(http://asiafoundation.org/publications/pdf/996) had this to say: "The privatization of MWSS was clearly a triumph of the principle of comparative competence -- the private sector proved more competent at the delivery of water and sewerage services than the state. It is now considered a singularly successful structural reform in the annals of Philippine political economy."

I have heard Sec. Purisima refer to this privatization in a public forum as a most successful PPP, which bears emulation. The administration of President Aquino has pinned its hopes on PPP to deliver needed infrastructure to address woeful backlog, raise the productivity and performance of the economy, and improve the quality of life of our people, while keeping to its fiscal program.

Amidst calls for short-sighted tariff reductions, I truly hope that Philippine authorities will take the long view that seriously considers the quality water service requirements of present and future water consumers and safeguards the environment. And faithfully implement the MWSS Concession Agreement with continuity, consistency and fairness. Future private investments throughout the country  in water and in other needed infrastructure critically hinge on it.

Romeo Bernardo was Finance undersecretary during the Aquino 1 and Ramos administrations, and board director of Institute of Development and Econometric Analysis, Inc.

Markets stirred; economy to chug along

Business World
Introspective

JUST TWO weeks after the government announced a much-better-than- expected 7.8% GDP growth in 1Q2013 that bucked the regional growth slowdown, local stock prices grabbed headlines with the worst one-day dive since the Lehman crisis in October 2008. Many were stunned by the steep fall, especially following a new round of upgrades in analysts' growth forecasts. Some feared that the much talked about asset bubble had finally burst. Still others, who had missed the amazing bull run, are wondering if now is a good time to buy.

In truth, financial market volatility has greatly increased since the US Fed started hinting at slowing down its bond buying program with worries about a rapid rise in interest rates exacerbated by the Bank of Japan's recent decision not to expand its monetary stimulus. Thursday's 442-point drop (6.7%) in the Philippine Stock Exchange Index (PSEi) followed a month- long downtrend that saw the PSEi losing a cumulative 15% since a 7,403 intra-day record high was reached last May 15. The losses extend to the bond and currency markets with local interest rates having risen by over 70bp on average since mid-May and the peso losing about 5% against the dollar over he same period.

Rather than a change in internal fundamentals, we think that the drop in the equity, bond and peso markets are more a reflection of portfolio flows going back to the US with its emergent recovery and expectations of an end to the Fed's quantitative easing. Compared with other emerging markets, local financial prices may have been affected more because Philippine assets are among the most overvalued (e.g., very high price- earnings ratios) due in large part to past capital inflows attracted to the country's growth story and prospect of investment grade ratings. With the upgrade to investment grade already achieved and no clear further upside play, foreign players appeared to have decided to cash in earnings, with recent data releases showing poor numbers for FDI and exports as well as the World Bank's downward revision of world growth used as reasons for players to exit.

In fact, we are looking at significant upward adjustments to our growth forecasts for this year (from 6.1% to 7.2%) and next (from 5.8% to 6.2%.

But this is mostly based on the business cycle rather than a permanent structural shift that prospective investors, including a new class of players that can only invest in investment grade markets, may be waiting for. Our GDP revisions reflect largely the high current election-related spending growth, including likely frontloading in public infrastructure that may last only up to this quarter, and the ongoing private construction boom, a lagging indicator of past investment decisions in residential and business buildings that according to industry experts, take two to three years to complete.

The maturing of this cycle and rising interest rates will bring growth back to more normal levels, perhaps as early as late 2014 or early 2015. The much-hoped for revival of investments in PPP or in industrial zones may not be significantly large to keep growth high beyond 2015.

Meanwhile, the Monetary Board has kept its policy stance unchanged, with key borrowing and lending rates at 3.5% and 5.5%, respectively and the SDA rate at 2%. It had previously slashed the SDA rate by a cumulative 150bp and last month announced limits to trust accounts' access to the facility which will be phased over the next six months. In light of the capital outflows, the monies expected to be pushed out of the SDA facility are not expected to be inflationary and given their conservative risk profile, will likely have limited impact on prices of risky assets. The peso's depreciation is also welcome news. Both developments (SDA changes and weaker currency) will help to repair the BSP's balance sheet and increase policy flexibility.

This column was culled from a recent GlobalSource report written by Christine Tang and the columnist. Romeo Bernardo is Philippine GlobalSource advisor and is a board director of IDEA.

Policy quadrilemma

Business World
Introspective

IN A repeat move, the Monetary Board last week brought down the rate on its Special Deposit Accounts (SDA) while keeping key borrowing and lending rates steady. The latest 50bp reduction brings returns on SDAs to 2.0% which, added to the previous cut, will save the BSP over P20 billion in interest costs over a one-year period on about P1.9 trillion parked in SDAs.

While acknowledging the beneficial impact on BSP's bottom line, monetary authorities have also been quick to point out that the SDA rate cuts have not been done solely to slow the bleed in its income position. Rather, the official line is that the cuts are intended to push monies out for more productive uses and are part of plans to go into an interest rate corridor approach to conducting monetary policy.

But the large cash drain is hard to ignore. The official Web site shows that the BSP has accumulated losses reaching 1.7% of GDP in the three years to November 2012 and these have eaten into its capital which has fallen from over P200 billion in 2009 to only P58 billion as of the period. At the same time, similar to some other central banks, it is accounting for paper gains or losses by reporting these as either a net asset (e.g., if peso appreciation reduces the value of the international reserves) or a net liability (if a net gain), rather than charged directly to capital. November 2012 data show that these revaluation losses amounted to P55 billion, which if deducted from capital leaves a net worth of P3 billion. This has since been boosted by a P20-billion capital infusion by the national government towards the yearend.

Nevertheless, considering continuing quantitative easing by major central banks, analysts have started to ask whether the BSP can hold the line and if its mounting costs and expectations of negative capital would influence policy decisions. In the context of the impossible trinity (i.e., one cannot enjoy policy independence, exchange rate stability and capital mobility all at the same time), the question is which one will it have to let go?
It is easy for market players to forget that unlike commercial banks, central banks are not out to make profits albeit they are inherently profitable. As the issuer of the currency and depository of banks' reserve requirement (both these liabilities are equity-like), they fund asset purchases at virtually zero cost. Moreover in carrying out policy operations, they are in the position to borrow when interest rates are low (to mop up excess liquidity in a cash-rich situation) and lend when rates are high (to inject liquidity). Hence, the orthodox view in economics is that a central bank's financial position does not form part of the policy- making equation and that negative capital is meaningless since it can always just print money to erase the losses as long as it is willing to tolerate higher inflation.

While this may well be the textbook case, real world conditions make the central banker's task more complicated. In the recent case of the Philippines, the net losses stem from monetary authorities' efforts to achieve the twin policy goals of currency and price stability in an environment of easy money globally. With a robust current account position to start with, the large inflow of yield-seeking foreign funds and ensuing BSP action to minimize sharp peso appreciation and mop up excess liquidity have dramatically changed its balance sheet structure.

The BSP is not alone in this. One can find many examples of central banks around the world that periodically incur losses or even at some point operated with negative capital for long periods of time (e.g., Czech Republic, Chile) without raising concerns about their credibility and effectiveness to carry out policy. After all, central banks do have seigniorage revenues from currency issuances and cost-free RR deposits. In the case of the BSP, one estimate is that based on current inflation and economic growth outlook, it can fund additional, moderate increases in foreign reserves from seigniorage without prices spiking beyond its tolerance range.
And despite what looks like depleted capital on paper, the BSP in reality has a sound balance sheet that in times of stress in the external accounts when central bank strength and credibility is most needed will automatically improve with the peso's depreciation. At that point, it will also be able to sell its dollars at a profit and the decline in its reserve holdings will help reduce the negative carry. Cuts in the policy rates and signals of more cuts ahead suggest to us that indeed, its losses have entered the policy equation. But given the above, this is unlikely to have been driven by economic considerations but, due to its history, by political and reputational risks of being perceived as having weak finances.

What then moving ahead? How will the BSP resolve its policy trilemma or rather, quadrilemma?
The BSP will likely favor instruments and policies that limit its losses, including measures that reduce the running losses on its negative carry such as lowering the SDA rate which the Governor has hinted at or resorting to using the reserve requirement on bank deposits, which are non- interest bearing, to fund asset purchases (either raising the existing ratio or imposing RRs on trust products).

The risk with bringing the SDA rate even lower is the potential for asset bubbles in the already frothy stock and property markets. Considering that SDA volumes have continued to rise, it is not clear at this point if and by how much the interest rate cuts will whet investors' risk appetite especially since bond yields are already dropping in anticipation of more cuts. But a safe assumption is that a portion of any SDA withdrawals will be used to fund increased government domestic borrowings, or in the case of foreign funds that have circumvented the BSP ban, their exit will contribute to a weaker peso and thus will be good for the BSP's books. Still, if the lower rates induce banks to lend too aggressively, the BSP may then switch to raising reserve requirements apart from tightening prudential limits further.

On the other hand, if heavy capital inflows persist despite the rate cuts, BSP may tolerate a larger peso appreciation, i.e., reduce its dollar purchases from the market and its associated sterilization. Already, it has passed some of the burden of keeping the exchange rate competitive, a public policy objective, to the national government (NG) with the latter prepared to exclusively tap the local market for its (re)financing requirements this year. The NG can do more, e.g., by speeding up infrastructure investments (or approvals for private investments) which will help raise the demand for dollars or encourage the two government-run pension institutions, GSIS and SSS, to invest overseas, which is allowed under their charters. At the same time, in light of apparent closer coordination and the NG's improved fiscal position, the BSP and NG can also work out other arrangements, including seeking new legislation.

There are also talks of creating a sovereign wealth fund that will allow a portion of the BSP's international reserves to be invested in riskier assets that earn higher returns, which can help narrow if not close the negative carry. Increasing the BSP's capitalization by law is also being considered. Legislating a capital/net worth band-an automatic top-up if BSP capital falls below the lower end of band, and an automatic payout to the national government whenever it exceeds the top end - as now being discussed in our FINEX policy study group, may well be the definitive solution to this fourth corner of BSP's quadrilemma.

Part of this column came from GlobalSource Market Brief, with the same title, written by Christine Tang and the columnist. Romeo Bernardo is a board director of IDEA. He served as Undersecretary of Finance during the Aquino 1 and Ramos administrations.

Why is the debt ratio rising?

Business World
Introspective

THERE HAS been a fair amount of curiosity directed at the government's announcement that the national government's debt stock rose 9.8% in 2012, translating into a higher 51.4% ratio to GDP from 50.9% previously. The puzzlement stems from observations that given a primary surplus, a higher GDP growth vs. interest rate and the peso's appreciation, the debt ratio should have fallen markedly. So why did it increase?

A decomposition of the increase in the national government (NG) debt level from 2011-12 shows a significant buildup in cash based on available data up to November. To us, this reflects a familiar pattern among large local borrowers who have recently been taking advantage of favorable domestic credit conditions to lock in cheap financing for expected expenses in the near term. The treasury bureau raised a record P188 billion from the sale of retail treasury bonds last October, with the 25-year debt papers yielding a low 6.125%.

In informal exchanges through e-mail, National Treasurer Rosalia de Leon explained that the cash pile is intended for a number of upcoming operations. These include:

On-lending to the Power Sector Assets and Liabilities Management Corp. (PSALM), the corporation tasked to oversee government's exit from the power generation business under the Electric Power Industry Reform Act.

This is not unusual. The NG occasionally borrows on behalf of public corporations to keep borrowing costs for the entire public sector down. This was done last year with the Treasury extending P55 billion to PSALM, which contributed to the rise in the debt ratio. A direct government borrowing saves at least 25 bps compared to a PSALM one with a sovereign guarantee. For 2013, a similar amount is expected to be on-lent to PSALM.

Buying back $1.5 billion worth of high-coupon dollar denominated bonds. Retiring expensive, short-dated, foreign currency-denominated and illiquid debts has been a key component of government's debt management program to help reduce its debt servicing costs and lower currency and roll-over risks, including by lengthening the maturity and liquidity profile of government securities. However, these benefits come at the cost of somewhat elevating the reported debt stock, a cost that government is able to bear at this time given the fiscal space created under this Administration.

For example, in late 2012 government spent $1.46 billion buying back $1.2 billion worth of securities. The higher cost may be traced to the price premiums attached to the retired bonds which carried higher coupons relative to the then prevailing market interest rates. Because a portion of the payment was sourced locally with dollars bought from the BSP, the transaction additionally helped to reduce appreciation pressures on the peso.

The remainder is programmed to be contributed into the bond sinking fund for maturities in early 2013.
On the whole, we think that the rise in the debt ratio is not a cause for worry and should not prevent government from getting its much desired investment grade rating. Based on the Treasury's deposits with the BSP as of November, netting out the cash as is standard practice in debt analyses in private companies should see government's debt ratio last year drop below the 50% posted in 2011.

More importantly, government has a much improved debt profile since 2005 in terms of sourcing, currency and maturity as well as a sizeable drop in interest costs relative to revenues. Overall, these translate into more sustainable debt dynamics and reduced vulnerability to interest and exchange rate shocks.

This column was excerpted from a GlobalSource Market Brief with the same title written by Christine Tang and the columnist. Romeo Bernardo is a board director of the Institute for Development and Econometric Analysis. He was Undersecretary of Finance during the Aquino 1 and Ramos administrations.

The 'Strong' Peso Problem

Business World, Introspective

In its latest attempt to deal with speculative inflows, the Bangko Sentral ng Pilipinas (BSP) capped in the last days of last year, individual banks’ ability to enter into non-deliverable forwards (NDF) and announced that it has also set a system-wide limit for internal monitoring.  This is just the latest serving in the BSP’s menu of options for managing the pressures of an appreciating currency.

The BSP has been wrestling with capital inflows all year round, supplementing its use of policy rate cuts (total of 100bp this year) and reserve accumulation (GIR up $8.6B to $84B as of November) with more unconventional tools aimed at speculators.  In January, it applied a higher risk weight on NDFs, successfully slashing NDF volumes from a reported high of $16 billion in mid-2011 to only $4 billion, and in July, banned foreigners from its special deposit accounts (SDA) but with less apparent success.

As it is, market sentiment on the peso is for further appreciation on top of the over 7% gain last year, among the highest in the region. This will attract more inflows as yields in mature markets are expected to remain low, and positive Philippine credit ratings outlook fuels expectation for investment grade rating this year.  Likewise, forecast surpluses in the current account due to growing remittances, BPO service exports and electronic export recovery will continue to provide the peso fundamental support. 

This is creating serious concern, not only for OFW workers, exporters and BPO players, but also manufacturers threatened by cheaper imports. Socio-economic Planning Secretary Balisacan has also publicly shared his worries on a further appreciation's broader impact on the economy.

An investment revival, including in government’s PPP program, may boost dollar demand and ease appreciation pressure as spending in import-intensive mass transport, water, power and other infrastructure projects suck up some of the foreign exchange inflows.  While financing from foreign equity investors as well as our traditional development partners can be expected to bring in dollars, something that should be encouraged considering a more long-term strategic perspective, a major part of the infrastructure investments will be done via local borrowing under the current favorable borrowing environment abundant liquidity and lengthening maturities.   

Pending such pick up in domestically financed capital imports, the Department of Finance can be more aggressive in cutting down its foreign borrowings from capital markets in favor of local financing and source payments for maturing dollar debts from the country’s international reserves.

Should portfolio flows continue unabated, the BSP has other measures it can consider, or likely already considering, which it can implement in a calibrated manner to respond to actual developments.

The record high level of reserves which earn very low interest rates vs. the SDA rate means the pressure on the BSP’s balance sheet has grown, and indeed, snowballs over time.  Just for the first three quarters of last year, it incurred a whooping P 68 billion in losses.  It may try to reduce the cost of that negative carry by lowering the policy/SDA rate, and rely more on less market based measures to mop up the liquidity that its dollar purchases generate. 

Such non-market based measures can include raising the reserve requirement on deposits or impose reserves on heretofore reserve-free holdings of banks, such as trust accounts under management. This would spread the cost to the banks which in turn will be passed on to savers. Care will need to be taken that this does not contribute to disintermediation, i.e. discourage savings in banks.

As allowed under its charter, the BSP may also try to earn a higher yield from the reserves by investing these in higher yielding securities, given the paltry returns it gets in the most prime ones it currently invests in for maximum safety. The current yield on five year US Treasury notes for example is under 1 percent, compared to the 3.75 percent that the BSP pays for SDA’s.  

There have also been proposals in Congress to set up a sovereign wealth fund to carve out a portion of the “excess reserves” to invest in development projects, including for state lending to small and medium scale industries. Unless carefully structured, and under an ideal administration, this may give rise to a host of governance/moral hazard concerns. Besides, we already have the SSS and the GSIS that are allowed under their charters to invest overseas. Urging these institutions to place a small fraction, say ten percent, of their investible funds to overseas investments will help the BSP in sucking up dollar flows, even as they align with global pension fund management best practice by diversifying their portfolio holdings.

If push comes to shove, the government can take stronger measures to control capital flows by way of a tax on short term placements, the so-called Tobin tax, as has been pioneered by Chile in the 90's, and which has been more recently used in Brazil on and off to manage foreign currency inflows and their impact on the exchange rate. However, I do not think our BSP is anywhere close to supporting such at this time. 

Part of this column came from GlobalSource Market Brief, Stemming the Tide, 28^th December 2012, written by Christine Tang and the columnist.  Romeo Bernardo is a Board Director of IDEA. He served as Undersecretary of Finance during the Aquino 1 and Ramos administrations. 

The 'strong' peso problem

Business World
Introspective

IN ITS latest attempt to deal with speculative inflows, the Bangko Sentral ng Pilipinas (BSP) capped in the last days of last year, individual banks' ability to enter into non-deliverable forwards (NDF) and announced that it has also set a system-wide limit for internal monitoring. This is just the latest serving in the BSP's menu of options for managing the pressures of an appreciating currency.

The BSP has been wrestling with capital inflows all year round, supplementing its use of policy rate cuts (total of 100bp this year) and reserve accumulation (GIR up $8.6 billion to $84 billion as of November) with more unconventional tools aimed at speculators. In January, it applied a higher risk weight on NDFs, successfully slashing NDF volumes from a reported high of $16 billion in mid-2011 to only $4 billion, and in July, banned foreigners from its special deposit accounts (SDA) but with less apparent success.

As it is, market sentiment on the peso is for further appreciation on top of the over 7% gain last year, among the highest in the region. This will attract more inflows as yields in mature markets are expected to remain low, and positive Philippine credit ratings outlook fuels expectation for investment grade rating this year. Likewise, forecast surpluses in the current account due to growing remittances, BPO service exports and electronic export recovery will continue to provide the peso fundamental support.

This is creating serious concern, not only for OFWs, exporters and BPO players, but also manufacturers threatened by cheaper imports. Socioeconomic Planning Secretary Balisacan has also publicly shared his worries on a further appreciation's broader impact on the economy.

An investment revival, including in government's PPP program, may boost dollar demand and ease appreciation pressure as spending in import- intensive mass transport, water, power and other infrastructure projects suck up some of the foreign exchange inflows. While financing from foreign equity investors as well as our traditional development partners can be expected to bring in dollars, something that should be encouraged considering a more long-term strategic perspective, a major part of the infrastructure investments will be done via local borrowing under the current favorable borrowing environment abundant liquidity and lengthening maturities.

Pending such pickup in domestically financed capital imports, the Department of Finance can be more aggressive in cutting down its foreign borrowings from capital markets in favor of local financing and source payments for maturing dollar debts from the country's international reserves.

Should portfolio flows continue unabated, the BSP has other measures it can consider, or likely already considering, which it can implement in a calibrated manner to respond to actual developments.
The record high level of reserves which earn very low interest rates vs. the SDA rate means the pressure on the BSP's balance sheet has grown, and indeed, snowballs over time. Just for the first three quarters of last year, it incurred a whooping P68 billion in losses. It may try to reduce the cost of that negative carry by lowering the policy/SDA rate, and rely more on less-market based measures to mop up the liquidity that its dollar purchases generate.

Such non-market based measures can include raising the reserve requirement on deposits or impose reserves on heretofore reserve-free holdings of banks, such as trust accounts under management. This would spread the cost to the banks which in turn will be passed on to savers. Care will need to be taken that this does not contribute to disintermediation, i.e. discourage savings in banks.

As allowed under its charter, the BSP may also try to earn a higher yield from the reserves by investing these in higher yielding securities, given the paltry returns it gets in the most prime ones it currently invests in for maximum safety. The current yield on five-year US Treasury notes for example is under 1%, compared to the 3.75% that the BSP pays for SDA's.

There have also been proposals in Congress to set up a sovereign wealth fund to carve out a portion of the excess reserves to invest in development projects, including for state lending to small and medium scale industries. Unless carefully structured, and under an ideal administration, this may give rise to a host of governance/moral hazard concerns. Besides, we already have the SSS and the GSIS that are allowed under their charters to invest overseas. Urging these institutions to place a small fraction, say ten percent, of their investible funds to overseas investments will help the BSP in sucking up dollar flows, even as they align with global pension fund management best practice by diversifying their portfolio holdings.

If push comes to shove, the government can take stronger measures to control capital flows by way of a tax on short term placements, the so- called Tobin tax, as has been pioneered by Chile in the '90s, and which has been more recently used in Brazil on and off to manage foreign currency inflows and their impact on the exchange rate. However, I do not think our BSP is anywhere close to supporting such at this time.

Romeo Bernardo is a board director of IDEA. He served as Undersecretary of Finance during the Aquino 1 and Ramos administrations. Part of this column came from GlobalSource Market Brief, Stemming the Tide, Dec. 28, 2012, written by Christine Tang and the columnist.