The Duterte SONA and legacy: tail risks and politic

September 1, 2019 | 11:39 pm

Introspective By Romeo L. Bernardo

This is the continuation of my column last week sharing our presentation to international subscribers of GlobalSource Partners (globalsourcepartners.com) at a teleconference on July 23.

So how do we get from our estimate of 6% to government’s 7-8% growth target? I would describe 7-8% as aspirational, considering especially the current global trade environment that has dampened export growth. Although we said Build, Build, Build will add to domestic demand growth, there is high import leakage (40-60% per IMF). An example is cement where imports have grown by a Compound annual growth rate (CAGR) of 30% in the last three years. Also, as we said, all the building activity will aggravate strains on traffic, logistics, and power supply, not to mention that manufacturing plants have been operating at over 80% capacity for some time now.

So, growth will be 6%, maybe even 6.5%, inflation is under control especially with freer rice trade, and markets expect easier local monetary policies ahead consistent with the US Fed’s stance. For a time, there were worries about rising risks from the twin deficits, fiscal and external, in an environment of tightening global monetary and financial conditions. But these have subsided with the changed environment and, at the end of the day, we go back to the basic driver of both deficits which is domestic investment activity, both public and private, which are necessary to propel GDP growth to higher rates in the future. Also, the country has built up ample international reserves to serve as a cushion for higher current account deficits. Based on the IMF reserve adequacy computations, the Philippines has one of the highest ARA (Assessment of Reserve Adequacy) metric (1.83 as of June).

Let me add a word on the trade war. Exports, though still important, have not been big driver of Philippine growth. To illustrate, per our estimate, on a value-added basis, export earnings last year amounted to $35 billion or 11% of GDP compared with a total of $50 billion or 15% of GDP for remittances and BPO. Ten years ago, the comparative numbers were both around 14% of GDP. So, my prognosis is that while we will be affected, the overall impact will not drag growth in a major way. But neither is the Philippines expected to gain significantly from ongoing shifts in production bases. Competitiveness issues remain the key constraints in the short-term. (N.B. Since our July teleconference, trade war and global recession risks have intensified with new Trump tweets and tariffs.)

I will also add three tail risks, one is on the sustainability of Philippine Online Gaming Operator (POGO). The other is a possible power shortage, and the third is a key man risk.

First, the risk that the POGO game ends. There has been talk about Premier Xi Jinping asking for President Rodrigo Duterte’s help to do something about it, a strange request until one considers how closely the industry is perhaps tied to the Duterte administration’s China pivot. However, its continued growth, or even existence is vulnerable to change in the Chinese government’s sentiment, for example, less friendly relations with the next Philippine administration, or a crackdown on money laundering that could be initiated by Chinese authorities or multilateral watchdogs. A sudden stop would have adverse effects not only on direct employment but also on real estate prices, office space demand, and banking profitability. (N.B. POGO’s “game over” risks has increased considerably with progressively firmer diplomatic communications against it by the Chinese embassy since our July teleconference.)

My second tail risk is a power shortage. From a situation of surplus power forecast three years ago, the main grid — which includes Metro Manila services — suffered sporadic shortages and red and yellow alerts earlier this year due to unplanned outages/plant shutdowns and the El Niño drought. Reserves have grown thin due to delays in approvals of several power plants, a long story involving the Supreme Court, the Energy Regulatory Commission (ERC), weak oversight and slow regulatory response. While the ERC seems to be trying to clear the backlog, there is a tail risk that the thin reserves will grow even thinner should there be more delays before new plants come on stream to meet the growing power demand in line with GDP growth.

My third tail risk is a key man risk. If, for whatever reason, Finance Secretary Carlos Dominguez III drops out of the scene, all bets are off. Secretary Dominguez, a highly regarded business executive and technocrat, a classmate of President Duterte from kindergarten and his most trusted political ally and confidant for decades, is likely irreplaceable. Without Secretary Dominguez, it may be difficult to check populists measures that threaten macro stability.

I now come to my last topic, politics. Notwithstanding his international image as a despot, President Duterte is very, very popular locally. He enjoys the support of 85% of Filipinos nationwide and he drove the point home in his State of the Nation Address the other day by highlighting the fact that only 3% of survey respondents disapproved of him, the other 11% are “undecided.” Such approval ratings are historically unparalleled.

For a while, there were concerns that the President, with this much political capital and overwhelming influence over the country’s democratic institutions (Congress, the Supreme Court, constitutional bodies such as the Ombudsman, Comelec), and unrestrained in dealing with the media, the church, oligarchs, however he defines them, or anyone in the opposition, may try to do what it takes to change the Constitution and shift to whatever form of government that would keep him in power. At least based on what he said in his State of the Nation Address, he appears to have given up on the campaign promise to a shift to federalism (which his economic managers called “a fiscal nightmare.”) Not a word was mentioned on it during his speech and he told media afterwards that “I’m out of it.”

But he is clearly not a lame duck at this point. After the midterm elections, he has even stronger supermajority support in both houses of Congress. And, without the charter change distraction, the next one to one-and-a-half years would be good for the economic reform agenda. This is why I am very confident that the remaining tax reform packages will pass quickly.

After that, the last year, year-and-a-half of the presidency would be mostly about succession and positioning for the 2022 presidential elections. The Philippine Constitution limits the president’s term of office to a single six-year term. In one of our earlier reports, we observed that historically, only one incumbent, Cory Aquino, had succeeded in making her anointed successor, Fidel Ramos, win, and narrowly at that. History has not been kind to ex-Presidents who did not manage their succession well. Since 1986, one went into exile, one was under house arrest after being thrown out of office, one spent five years in a military hospital with a neck brace. The last president has several criminal cases hanging over his head.

President Duterte’s goal then for 2022 is to choose a successor who will keep him out of harm’s way. This is where his daughter and her HNP (Hugpong ng Pagbabago) party come in. The daughter is Davao Mayor Sara Duterte, who rose to fame decades ago by punching, on camera, a local government executive who went against her orders in an incident involving the demolition of shanties. Like the father, she is a very popular figure and the betting at present is that she will be the anointed one.

But it is too early to say who the “Presidentiables” will be in 2022, much less who will prevail. Random names I’ve heard include any of three Villars (ex-Senator Manny Villar, ranked richest in the Philippines by Forbes magazine, his wife Cynthia who topped the last senatorial race, and their son, current Public Works Secretary Mark), Senator Grace Poe (who ran and lost to President Duterte), and Senator Manny Pacquiao, the Pacman.

We need to bear in mind some history lessons from Philippine elections. One, in a multi-contested election, as has been recent history, a candidate without a clear majority can win. Winners have been surprises. Two, I am also reminded that “necropolitics” has defined presidential election outcomes on more than one occasion in the past. The story of both Aquino presidents. A third lesson from election history, unlike elsewhere, here it is not the early bird who catches the worm. It is the second mouse who gets the cheese.

And speaking of necropolitics, my political tail risk is the death of President Duterte in office. The President is 74 years old and rumored to be sick. His Vice-President, Leni Robredo, an opposition leader, has reportedly doubled her security detail to discourage any assassination attempt by those who may be adversely impacted by inevitable drastic changes. Even the more likely smooth assumption, as the Constitution mandates, could be disruptive — there will be changes in policy across a wide field, projects will be reviewed, there will be leadership changes across major departments.

To summarize: The key messages I would like to leave with you today are: 1.) the economy is doing well thanks to the economic team that has also been able to push for good economic reforms; 2.) the Build, Build, Build infrastructure program is moving forward with government spending reportedly up to 5% of GDP, a level that I think can be sustained through 2022; 3.) economic growth at 6% to 6.5% over the next three years is resilient but will be hard to sustain if higher than that; and 4.) on the political side… well, we don’t really know… the genius of the man is in keeping everybody guessing.

Romeo L. Bernardo was finance undersecretary during the Cory Aquino and Fidel Ramos administrations.

romeo.lopez.bernardo@gmail.com

Duterte defined: His SONA and his legacy.

August 26, 2019 | 12:11 am

Introspective By Romeo L. Bernardo

ON July 23, my colleague Christine Tang and I were asked by GlobalSource Partners New York* to do a teleconference call with our international subscribers on the topic in the headline. I am pleased to share with readers the transcript of that call. Apologies, this will have to be in two parts. The second installment will be on the risks to this cautiously optimistic scenario, and some political analysis — what the President will likely do with his abundant political capital and the odds of policy continuity post 2022.

I will talk about the following key points:

1. First, the economy under President Duterte, which is doing well in terms of economic growth and stability. The reform agenda is also progressing better than expected.

2. Second, the administration’s Build, Build, Build program, intended to usher in a “Golden age of infrastructure.” The Gold (medal) is aspirational, but efforts may yet earn the administration a Bronze.

3. Third is an assessment of economic prospects in the next three years under President Duterte. I think growth will be resilient at 6%, or even 6.5%, but will be hard to sustain if higher than that.

4. Finally, tail risks and politics.

et’s start with the economy under Duterte: so far so good.
The President’s economic management style from Day 1 has been to give his economic managers a free hand. Led by his finance secretary Carlos Dominguez III, the economic team hit the ground running and announced a 10-point agenda that hewed closely to the policies, programs and projects of past administrations. The team had its challenges along the way, for example the delay in the passage of this year’s budget and last year’s inflation spike but by and large, the economic team has been successful at maintaining macroeconomic stability, i.e., keeping growth above 6% and steering inflation back within target, it is below 3% now.
Many have also noted that under this administration, the masses have shared in economic growth, with surveys showing a lower number of people identifying themselves as poor, unemployment rates continuing to fall and the quality of jobs improving. Reasons for this include income tax cuts implemented by this administration as well as a number of social programs that have increased households’ disposable income, e.g., free college tuition, higher pensions, conditional cash transfers and universal health care. Although we and other analysts have flagged the rising fiscal costs of these and other subsidy programs, so far, the fiscal burden has been limited.
The other notable achievement of the economic team is the passage and implementation of difficult economic reform measures that have earned the sovereign credit a BBB+ ratings upgrade from S&P. On the fiscal side, the TRAIN (Tax Reform for Acceleration and Inclusion) law for example, which replaced losses from lower personal income tax with higher consumption taxes especially on oil, raised the tax effort by 1% of GDP in its first year of implementation. These revenue inflows have helped to fund higher public spending on social services and infrastructure while keeping the budget deficit at around 3% of GDP, a fiscally sustainable level, per the IMF.
Other reform measures include the game changing rice tariffication law, a reform three decades in the making that has brought down rice prices, as well as the anti-red tape law, the BSP Act, National ID and the Bangsamoro Basic Law. The next stage challenge of implementing these reform measures as designed is underway, and the political will to do so seems to be there based on the explicit statements of the President during his State of the Nation Address.

SECOND POINT

The one activity that has defined this administration’s economic program to date is the Build, Build, Build infrastructure program, my second discussion topic.

Historically, over the last three or four decades public spending on infrastructure averaged only around 2% of GDP, a far cry from the average of 5% of our neighbors. The failure to invest is showing badly in congestion on roads, rails, sea ports, air ports. Slow approval processes are also beginning to affect the power sector which has been privatized. Failure to develop water sources by government has also caused water shortages in Metro Manila.

The last administration managed to raise infrastructure spending but only up to 3% over a six-year period. What the Duterte administration did was to raise spending to 5% of GDP three years into its term. And, through an ambitious infrastructure program, it intends to ramp up spending to 7% of GDP by 2022, the end of its term. This, economic managers say, is consistent with the target 7-8% GDP growth.

But I doubt that they can achieve these targets nor do I think it desirable to ramp up infrastructure spending so quickly. Experts I talked to question not only what makes up the 5% of GDP spending but they tell me that the quality of the projects pursued so far are not all growth enhancing. Many involve maintenance works on existing facilities some of which are superfluous. IMF estimates also show low efficiency of public investments in the Philippines, suggestive of large leakages.
My take is that is that if government could only maintain infrastructure spending at the current 5% of GDP over the medium term, that would already be a big achievement, especially if that 5% is spent on good projects that have high economic returns.

In any event, at 5% of GDP, BBB will be an important driver of GDP growth in the next three years, although all the construction activity is adding to chokepoints to economic growth in the short-term and it will take perhaps two more years for us to feel the decongestion effects of ongoing projects.

THIRD POINT

This brings me now to my third discussion point, the resilience of a 6% economic growth for the Philippines.

First, let me go over the structural factors underpinning the 6% economic growth rate. Philippine GDP trend growth rate has risen from an average of about 3% in the 1990s to 4-5% in the 2000s, to above 6% from 2010 to 2018. There are three reasons behind this rising trend growth.

One is demographics. The country has a young population, over 60% are in the working age group and this number will grow by 60% over the next two decades. The growth impact of this is evident in resilient remittances and the expansion of the BPO sector that have fueled domestic consumption and raised demand for retail trade services, financial products, and a real estate boom.

The second factor is the combined impact of past reform efforts on total factor productivity. Due to the reforms beginning in the 1980s (trade and foreign exchange liberalization, opening up of telecommunications and financial sectors, privatization of power), the contribution of total factor productivity to economic growth has grown from only 0.5 ppt in the 1990s to over 2 ppt this decade (Source: BSP).

Third is the growth of the middle class, which we think will continue to feed the consumer sectors. The rising importance of the middle class is an upshot of decades of sustained high remittance and BPO sector growth, both continuing but maturing and thus expected to grow at lower single-digit rates. A recent phenomenon that has taken up the slack left by slowing remittance and BPO growth rates is online gambling. The emergence of this sector has seen an estimated 200,000 Chinese workers moving to the Philippines, pushing up demand in real estate, construction, retail trade, etc. Young, single, and earning roughly $12,000 a year, this group is adding to middle class demand with spending potential approaching 1% of GDP.

(To be continued.)

*https://www.globalsourcepartners.com/


Romeo L. Bernardo was finance undersecretary during the Cory Aquino and Fidel Ramos administrations.

romeo.lopez.bernardo@gmail.com