THE FINANCIAL EXECUTIVE
Business World
Should government fund and run credit programs targeted at underdeveloped sectors that have difficulty accessing credit? In 1999, after decades of failed experiments with various types and modes of directing subsidized credit to individuals or groups in the agricultural and microenterprise sectors, government, through Executive Order No. 138, finally said no and stopped its nonfinancial agencies from continuing to grant loans to target sectors.
Instead, under EO 138, government was to focus on putting in place a policy environment conducive to private sector participation through the adoption of market-oriented financial policies. Even government financial institutions were supposed to concentrate more on wholesale lending, leaving retail lending to private financial institutions.
The lessons - huge and hidden fiscal costs from subsidized interest rates, poor repayment rates given beneficiaries' dole-out mentality, high administrative costs, unsatisfactory outreach with the poor continuing to lack access to credit despite the proliferation of government credit programs, distortive impact on financial markets given subsidized interest rates offered under the programs - had finally hit home.
Or so everybody thought.
Two days before the seventh anniversary of EO 138, President Arroyo signed EO 558 repealing EO 138. The move caught everyone, including officials in the Department of Finance, by surprise. The timing was ominous. With just nine months to go before the 2007 local elections, EO 558 gave government back an off-budget, high visibility tool that can easily be used to win votes. It demonstrated once again this administration's readiness to sacrifice long-term development goals to secure its hold on power.
Indeed, there is no rationale for repealing EO 138. EO 558 certainly does not provide one and the Palace's defense - to enable government agencies to supply credit in poor areas not reached by financial institutions - has been shown time and again to be ineffective in combating poverty (better for government to focus on support and capability building services to help the poor become bankable). Thus, in one stroke of a pen, the President simply undid all the work that successive administrations since the time of President Aquino had put into the effort - the Aquino administration made it a policy to abolish direct lending by government nonfinancial agencies; the Ramos administration created the National Credit Council to rationalize all directed credit programs; the Estrada administration articulated in EO 138 government's policy on directed credit programs.
In fact, EO 138 was part of a package of measures that included the Social Reform and Poverty Alleviation Act, Agriculture and Fisheries Modernization Act, the General Banking Law of 2000 and the Barangay Micro Business Enterprise Act, to help improve the policy environment for microfinance.
And EO 138 was working, too. More and more, private financial institutions were extending credit to microentrepreneurs. In recent speeches, BSP Gov. Say Tetangco noted that from about 55 banks claiming to do microfinance before 2000, there are 193 private financial institutions, with a portfolio of P3.3 billion and an outreach of over 600,000 beneficiaries, engaged in microfinance operations today.
Thus, by repealing EO 138 and paving the way for government to reenter the financial market as direct subsidized credit providers, the President is not only risking its hard-won fiscal battle, it is telling private financial institutions to get out of the microfinance business, since after all, they are constrained by market realities and will not be able to compete with the subsidized interest rates that government charges.
However, government does not have that much money to meet the huge demand for micro-credit. Moreover, with its limited funding and poor track record in microfinance, it will likely take only a few loan cycles for its funds to dry up. Sadly, without the clear policy rules provided under EO 138, private sector players cannot be expected to jump right back in knowing that government can anytime render their business models unviable. In the end, small entrepreneurs' lack of access to credit will come back to haunt the economy.
President Arroyo needs to do what is right and withdraw EO 558.
Tuesday, September 12, 2006
Friday, January 20, 2006
Musings on the year of the (she) dog
THE FINANCIAL EXECUTIVE
Business World
Going into the new year last year, one of the foremost concerns of analysts in business and academic circles was the prospect of a debt crisis as continued poor revenue effort constrained government's ability to rein in its rising debt ratio. While there remained a lot of hope given remittance-driven domestic economic growth, the fear then was of an event-triggered fiscal blowup, with government unable to refinance its maturing obligations and forced to default on its foreign currency-denominated debt, a large chunk of which was held by domestic banks.
2005 came and went and thanks to excellent fiscal, debt and monetary management and the passage at last of the EVAT law, there was no debt crisis; but as expected, the economy just muddled through. A welcome development was that despite the "Hello Garci" political storm and "Hyatt 10" resignations, yields on government dollar debt papers, a.k.a. RoPs, remained steady. In fact, even before the EVAT was finally implemented in November, some investment houses were giving an "overweight" recommendation on Philippine government credit.
A lot of the interest in RoPs (and other emerging market debt for that matter) was attributed to "liquidity" in global financial markets. What was not evident, however, was who these investors were. Apparently, as discussed in the latest issue of the IMF's Global Financial Stability Report and reported in a recent issue of The Economist, there has been an increase in the size and importance of institutional investors such as pension funds (according to The Economist, these institutional investors invested some $7.3 billion in emerging markets in the first half of 2005, 74% more than the comparable period in 2004).
As pointed out in the IMF report, what is significant about this development is that given these funds' long-term orientation, they are less likely to just up and leave on market noise and thus, may have a stabilizing effect on the market. Moreover, with a more sophisticated investor base able to distinguish between idiosyncratic and systemic events, there is less risk of contagion similar to the 1997 Asian crisis. This development, coupled with the earlier observation that domestic investors, who have greater appetite for Philippine risk, hold some two-fifths of Philippine government securities through the banking system, makes the prospect of an abrupt market shutdown unlikely over the short-term.
Still, there is nothing to stop these institutional investors from gradually reducing their exposure to the Philippines if economic fundamentals fail to improve materially over time and especially when compared with progress in other emerging markets.
Entering 2006, the fact that global financial markets remain liquid, or that government is expecting to improve its tax collection with EVAT, or that local financial markets appear bullish as seen in the gains in local stock and bond markets and the strengthening of the peso, should not be taken to mean that "the runway is clear and takeoff is at hand." Behind these headlines are stories of doctors turning to nursing to better provide for their families, of weak dollar demand because of declining fixed investments (due in turn to the political problems and high oil prices), of the rise in portfolio investments (encouraged by the passage of the EVAT) which, nonetheless can flow the other way any time.
In the end, all we're seeing may just be a break from the endless battles that this presidency has had to engage in and will likely continue to have to face if it is not able to get its act together and plan out steps to quickly revive investments. In this regard, well thought-out pro-poor spending - say on education, water and key infrastructure - would certainly make more sense than doling out government "savings" in food subsidies similar to the short-lived Kadiwa program in the '80s.
After all, risks to global growth remain (e.g., from oil prices, interest rate hikes) and the Philippines needs to work on strengthening its economic fundamentals to have enough cushion against any negative shocks.
The year of the dog is expected to bring good fortune. Lady Fortune, however, is known for her fickle moods.
Business World
Going into the new year last year, one of the foremost concerns of analysts in business and academic circles was the prospect of a debt crisis as continued poor revenue effort constrained government's ability to rein in its rising debt ratio. While there remained a lot of hope given remittance-driven domestic economic growth, the fear then was of an event-triggered fiscal blowup, with government unable to refinance its maturing obligations and forced to default on its foreign currency-denominated debt, a large chunk of which was held by domestic banks.
2005 came and went and thanks to excellent fiscal, debt and monetary management and the passage at last of the EVAT law, there was no debt crisis; but as expected, the economy just muddled through. A welcome development was that despite the "Hello Garci" political storm and "Hyatt 10" resignations, yields on government dollar debt papers, a.k.a. RoPs, remained steady. In fact, even before the EVAT was finally implemented in November, some investment houses were giving an "overweight" recommendation on Philippine government credit.
A lot of the interest in RoPs (and other emerging market debt for that matter) was attributed to "liquidity" in global financial markets. What was not evident, however, was who these investors were. Apparently, as discussed in the latest issue of the IMF's Global Financial Stability Report and reported in a recent issue of The Economist, there has been an increase in the size and importance of institutional investors such as pension funds (according to The Economist, these institutional investors invested some $7.3 billion in emerging markets in the first half of 2005, 74% more than the comparable period in 2004).
As pointed out in the IMF report, what is significant about this development is that given these funds' long-term orientation, they are less likely to just up and leave on market noise and thus, may have a stabilizing effect on the market. Moreover, with a more sophisticated investor base able to distinguish between idiosyncratic and systemic events, there is less risk of contagion similar to the 1997 Asian crisis. This development, coupled with the earlier observation that domestic investors, who have greater appetite for Philippine risk, hold some two-fifths of Philippine government securities through the banking system, makes the prospect of an abrupt market shutdown unlikely over the short-term.
Still, there is nothing to stop these institutional investors from gradually reducing their exposure to the Philippines if economic fundamentals fail to improve materially over time and especially when compared with progress in other emerging markets.
Entering 2006, the fact that global financial markets remain liquid, or that government is expecting to improve its tax collection with EVAT, or that local financial markets appear bullish as seen in the gains in local stock and bond markets and the strengthening of the peso, should not be taken to mean that "the runway is clear and takeoff is at hand." Behind these headlines are stories of doctors turning to nursing to better provide for their families, of weak dollar demand because of declining fixed investments (due in turn to the political problems and high oil prices), of the rise in portfolio investments (encouraged by the passage of the EVAT) which, nonetheless can flow the other way any time.
In the end, all we're seeing may just be a break from the endless battles that this presidency has had to engage in and will likely continue to have to face if it is not able to get its act together and plan out steps to quickly revive investments. In this regard, well thought-out pro-poor spending - say on education, water and key infrastructure - would certainly make more sense than doling out government "savings" in food subsidies similar to the short-lived Kadiwa program in the '80s.
After all, risks to global growth remain (e.g., from oil prices, interest rate hikes) and the Philippines needs to work on strengthening its economic fundamentals to have enough cushion against any negative shocks.
The year of the dog is expected to bring good fortune. Lady Fortune, however, is known for her fickle moods.
Tuesday, November 15, 2005
New minimum wage legislation: Playing with fire
THE FINANCIAL EXECUTIVE
Business World
With the expanded value-added tax (VAT) law finally implemented, we thought we can sleep soundly knowing we are on the road to fiscal sustainability.
Indeed, the country has begun to reap the rewards of taking this landmark measure, which can be seen in financial market gains.
To think the President did not initially support this (in fact, she called for the repeal of the VAT early into her 2004 term), but after her conversion, competent fiscal managers at the Finance department and enlightened legislators with the support of business and academia managed to carry it through.
Alas, Malacanang could not live well enough alone. Now this initiative to push for legislated minimum wages. It is hard to fathom why.
Since Tita Cory's time, the country has veered away from politicizing wage fixing and relied on regional wage boards instead to balance needs of generating employment, cost of living, and different local conditions. This has been working well so far with minimum wage increases exceeding inflation on average.
It is thus puzzling why this is now being put on the table.
According to economists from government, academia and business, the VAT reform bill, even counting already the 2-percentage point increase still to take effect next year, should not lead to an increase of more than 2.5% in the average cost of living of households.
If Congress is urged to intervene in wage setting it is highly unlikely that it will pass a mere 2.5% wage increase legislation, which translates to around P7 to P8 per day.
Indeed what we read in the papers are proposals to increase wages by P125 (roughly 40%), completely out of line with both inflation and productivity increases.
Indeed, that exactly is why government has moved away from a politicized wage setting process, realizing such politicized process that does not reflect market and competitiveness considerations is a recipe for driving away investments.
Already most job creation in recent years has been in the self-employed and informal sectors. Raising minimum wages will drive businesses underground to the informal sector or under the ground, shrinking not just employment, but output and government's already imperiled fiscal base (not to mention raising government's wage bill which already takes up almost a third of its budget). Worse, an increase that far surpasses inflation and productivity can only feed into a wage-price spiral (especially with second round impacts on inflation, e.g., from reversal of peso appreciation) and will hurt the poorest most.
So why is the Economist in Chief pushing for this?
The view propounded by friend Alex Magno in his column is that she has been swayed by PR advisers that this is good for her image.
Perhaps due to oversight, she has failed to consult her economic managers. Those who are not her admirers think it not likely that a brilliant economist like her can possibly suffer such a lapse of judgment; and postulate that she is also a brilliant political tactician.
Why not create an issue that will preoccupy her detractors both of the Makati Business Club and the Akbayan group types and throw them at each other's throats, so that they are diverted from the central issue that has occupied the nation.
I cannot believe that the President of a country will play with fire like so. (I have an economics professor friend though who does and I expect there are many like him. He told me I should stop arguing against high minimum wage legislation, even if it were to lead to a disastrous wage-price spiral. Says he, "I've gotten to the point where I don't give a damn. Let the place burn down. Sometimes it's the only way to get rid of rats.")
Waving free lunches and quick fixes is something one can expect from those who have no responsibility to deliver; not from a leader who has the task of articulating a clear vision and educating citizens on collective sacrifice needed over the long haul for the country and everyone to be better off.
The President should listen more to her economic managers who want to "firewall" the economy from the political clatter.
Mr. Bernardo is former undersecretary of the Department of Finance.
Business World
With the expanded value-added tax (VAT) law finally implemented, we thought we can sleep soundly knowing we are on the road to fiscal sustainability.
Indeed, the country has begun to reap the rewards of taking this landmark measure, which can be seen in financial market gains.
To think the President did not initially support this (in fact, she called for the repeal of the VAT early into her 2004 term), but after her conversion, competent fiscal managers at the Finance department and enlightened legislators with the support of business and academia managed to carry it through.
Alas, Malacanang could not live well enough alone. Now this initiative to push for legislated minimum wages. It is hard to fathom why.
Since Tita Cory's time, the country has veered away from politicizing wage fixing and relied on regional wage boards instead to balance needs of generating employment, cost of living, and different local conditions. This has been working well so far with minimum wage increases exceeding inflation on average.
It is thus puzzling why this is now being put on the table.
According to economists from government, academia and business, the VAT reform bill, even counting already the 2-percentage point increase still to take effect next year, should not lead to an increase of more than 2.5% in the average cost of living of households.
If Congress is urged to intervene in wage setting it is highly unlikely that it will pass a mere 2.5% wage increase legislation, which translates to around P7 to P8 per day.
Indeed what we read in the papers are proposals to increase wages by P125 (roughly 40%), completely out of line with both inflation and productivity increases.
Indeed, that exactly is why government has moved away from a politicized wage setting process, realizing such politicized process that does not reflect market and competitiveness considerations is a recipe for driving away investments.
Already most job creation in recent years has been in the self-employed and informal sectors. Raising minimum wages will drive businesses underground to the informal sector or under the ground, shrinking not just employment, but output and government's already imperiled fiscal base (not to mention raising government's wage bill which already takes up almost a third of its budget). Worse, an increase that far surpasses inflation and productivity can only feed into a wage-price spiral (especially with second round impacts on inflation, e.g., from reversal of peso appreciation) and will hurt the poorest most.
So why is the Economist in Chief pushing for this?
The view propounded by friend Alex Magno in his column is that she has been swayed by PR advisers that this is good for her image.
Perhaps due to oversight, she has failed to consult her economic managers. Those who are not her admirers think it not likely that a brilliant economist like her can possibly suffer such a lapse of judgment; and postulate that she is also a brilliant political tactician.
Why not create an issue that will preoccupy her detractors both of the Makati Business Club and the Akbayan group types and throw them at each other's throats, so that they are diverted from the central issue that has occupied the nation.
I cannot believe that the President of a country will play with fire like so. (I have an economics professor friend though who does and I expect there are many like him. He told me I should stop arguing against high minimum wage legislation, even if it were to lead to a disastrous wage-price spiral. Says he, "I've gotten to the point where I don't give a damn. Let the place burn down. Sometimes it's the only way to get rid of rats.")
Waving free lunches and quick fixes is something one can expect from those who have no responsibility to deliver; not from a leader who has the task of articulating a clear vision and educating citizens on collective sacrifice needed over the long haul for the country and everyone to be better off.
The President should listen more to her economic managers who want to "firewall" the economy from the political clatter.
Mr. Bernardo is former undersecretary of the Department of Finance.
Friday, September 16, 2005
RP debt swaps: No magic wand
THE FINANCIAL EXECUTIVE
Business World
With the government's debt stock at alarming levels, there have recently been increased calls for debt relief, not just from the usual suspects, but even from well-regarded professionals in the economics field. I find this bother-some as it lends credibility to something that has heretofore been rightly brushed aside. Speaker Jose de Venecia has even come up with a "Debt-for-MDG-Investments" (MDG referring to the UN's Millennium Development Goals) proposal, which has reportedly been warmly received by international bodies such as the UN and IMF.
While it is possible to do debt swaps here and there of a largely symbolic nature, it is not realistic to expect anything of the magnitude envisioned in the Speaker's proposal (i.e., free up some $2.25 billion in debt service annually for MDG projects for the Philippines). Especially not when from official creditor sources, one cannot (a) expect to free up much from bilateral (other government) debts since debt service on these loans are already low given their concessionality, nor (b) expect multilateral creditors to actively participate since they themselves are constrained by reliance on capital market access for 90% of their lending.
Where debt relief can be significant is on foreign-exchange denominated capital market debts, which make up 53% of outstanding government foreign debt. But here is precisely where calls for debt relief (default call, really) are counterproductive as these may send signals to the financial markets that the country is unable or unwilling to honor its debts. Debt relief calls can raise the cost of financing with a one-notch rating downgrade expected to increase interest cost by P550 million to P690 million based on the country's annual US$4-5 billion refinancing requirement. If taken seriously as a government position, it may lead to unintended payments crisis and may even trigger a banking crisis as Philippine banks hold a large percentage of outstanding Philippine foreign paper. Banks are leveraged institutions and even a small loss due to new mark-to-market valuation regulations can lead to capital impairment and bank runs.
Thus, not only would a debt relief operation be self-defeating for the Philippines, but it is difficult to imagine why, on purely economic grounds, official creditors would want to participate in a voluntary debt swap. After all, there is no default or immediate threat of default at this time, and as observed above, a contemplated default would put the banking system at peril.
Nevertheless, there may be some noneconomic reasons that would motivate official creditors/donors to participate in a debt swap. However, the only way this would not be costly for both sides is if amounts involved are small relative to total debts. But then, such token amounts will largely be insignificant and irrelevant to solving the country's debt problem. Moreover, the Philippines may lose overall in the likely event that an offsetting amount is carved out of the aid budget and with friction costs of doing a complex debt swap, the country will end up with less than what it would have gotten from a straight grant. This is even without counting any adverse impact such token deals can have on the cost of capital access not just to government but to the private sector as well.
Indeed, there are only two sensible ways of reducing the debt burden - to grow out of it through higher economic and export growth, and working towards reducing government's deficits over time, i.e., increasing the primary balance (equivalent of EBITDA). Thus, the energies of both the executive and legislature are better spent ensuring the attainment of these two goals rather than crafting and marketing debt swap deals that may lull the financially nonliterate to think there is a magic wand somewhere.
Mr. Bernardo is the president of Lazaro Bernardo Tiu & Associates, Inc. He was Finance undersecretary and ADB alternate executive director
Business World
With the government's debt stock at alarming levels, there have recently been increased calls for debt relief, not just from the usual suspects, but even from well-regarded professionals in the economics field. I find this bother-some as it lends credibility to something that has heretofore been rightly brushed aside. Speaker Jose de Venecia has even come up with a "Debt-for-MDG-Investments" (MDG referring to the UN's Millennium Development Goals) proposal, which has reportedly been warmly received by international bodies such as the UN and IMF.
While it is possible to do debt swaps here and there of a largely symbolic nature, it is not realistic to expect anything of the magnitude envisioned in the Speaker's proposal (i.e., free up some $2.25 billion in debt service annually for MDG projects for the Philippines). Especially not when from official creditor sources, one cannot (a) expect to free up much from bilateral (other government) debts since debt service on these loans are already low given their concessionality, nor (b) expect multilateral creditors to actively participate since they themselves are constrained by reliance on capital market access for 90% of their lending.
Where debt relief can be significant is on foreign-exchange denominated capital market debts, which make up 53% of outstanding government foreign debt. But here is precisely where calls for debt relief (default call, really) are counterproductive as these may send signals to the financial markets that the country is unable or unwilling to honor its debts. Debt relief calls can raise the cost of financing with a one-notch rating downgrade expected to increase interest cost by P550 million to P690 million based on the country's annual US$4-5 billion refinancing requirement. If taken seriously as a government position, it may lead to unintended payments crisis and may even trigger a banking crisis as Philippine banks hold a large percentage of outstanding Philippine foreign paper. Banks are leveraged institutions and even a small loss due to new mark-to-market valuation regulations can lead to capital impairment and bank runs.
Thus, not only would a debt relief operation be self-defeating for the Philippines, but it is difficult to imagine why, on purely economic grounds, official creditors would want to participate in a voluntary debt swap. After all, there is no default or immediate threat of default at this time, and as observed above, a contemplated default would put the banking system at peril.
Nevertheless, there may be some noneconomic reasons that would motivate official creditors/donors to participate in a debt swap. However, the only way this would not be costly for both sides is if amounts involved are small relative to total debts. But then, such token amounts will largely be insignificant and irrelevant to solving the country's debt problem. Moreover, the Philippines may lose overall in the likely event that an offsetting amount is carved out of the aid budget and with friction costs of doing a complex debt swap, the country will end up with less than what it would have gotten from a straight grant. This is even without counting any adverse impact such token deals can have on the cost of capital access not just to government but to the private sector as well.
Indeed, there are only two sensible ways of reducing the debt burden - to grow out of it through higher economic and export growth, and working towards reducing government's deficits over time, i.e., increasing the primary balance (equivalent of EBITDA). Thus, the energies of both the executive and legislature are better spent ensuring the attainment of these two goals rather than crafting and marketing debt swap deals that may lull the financially nonliterate to think there is a magic wand somewhere.
Mr. Bernardo is the president of Lazaro Bernardo Tiu & Associates, Inc. He was Finance undersecretary and ADB alternate executive director
Tuesday, August 23, 2005
Developing the Philippine capital market
SPECIAL FEATURE
Business World
Economic development and capital market development go hand in hand. As economies develop, the importance of a well-functioning capital market becomes paramount to ensuring that savings are channeled to their most efficient uses.
In turn, this ensures that risks associated with leveraging, as is the case with a financial system dominated by banks, sourcing foreign capital, and attendant foreign exchange risk due to mismatch with revenues, are kept at a minimum.
The extent of development of the Philippine capital market reflects the country's stage of economic development. The stock market, which has been around for more than 70 years, remains shallow and illiquid, with tax avoidance - lower capital gains versus income tax - or regulatory impositions the major for companies' decisions to list. The bond market is dominated by government securities, most of which are held to maturity.
Because of the importance of developing the domestic capital market to complement the functions of the banking system, domestic capital market development has been part of the government's reform agenda for decades. While there have been small steps forward every now and then (e.g., the recent removal of documentary stamp tax on secondary trades), by and large, the Philippine capital market remains underdeveloped.
Why is this so?
A fundamental reason is macroeconomic instability: The country's historical boom-bust economic growth pattern is a major deterrent to capital market development. The key concern at this time is government's fiscal problem, which makes it difficult for investors to take a long-term perspective given its potential destabilizing impact on growth and inflation. The government's large budget deficit is also a drag on the economy's savings rate, already low vis-a-vis other Asian countries. And without savings, there is no demand for capital market instruments. Thus, addressing government's fiscal problem, mainly through revenue measures, remains a top priority.
Some of the other issues at this time include the following:
Strengthening financial system
Strengthening the financial system, especially the banking system, and reorienting this to capital market development, is the first among these key issues. This requires resolving banks' bad asset problem given that banks are the 900-pound gorilla of the financial system, as banks account for over 80% of assets of financial system. Banks probably own a large part of the remaining non-bank sector - investment banks, insurance, stock brokerage, trust funds - outside of the government pension funds and dominate the government securities market.
Consolidation of banks through mergers will both strengthen the banking system and spur capital market development as an important pillar for financial reform. This can be done through stricter enforcement of trust regulations, among others, including revamping common trust funds (CTFs) into unit investment trust funds (UITFs), which are subject to higher levels of transparency and compliance to international accounting standards - e.g. mark to market - as well as making such more marketable to the investing public.
Together with mutual funds, such investment vehicles need to be encouraged as a way for small savers to have a wider range of savings medium. Other approaches for catering to small savers such as retail Treasury bills or the selling of stocks to small investors sound good but is actually bad economics - high transaction costs eventually result in buyers of such instruments being illiquid and ignored.
Pooled funds, on the other hand, provide small slavers convenience in participating in a more diversified and therefore less risky fund, access to the services of professional fund managers, and assurance and ease in liquefying investments.
Putting in place an enabling tax and regulatory framework that encourages such savings and investment vehicles is critical.
A study for harmonization of tax laws and regulatory regime for like products is being pursued by the private-public Capital Market Development Council. The Bangko Sentral ng Pilipinas (BSP) and the private sector members of the council are also pushing for the enactment of enabling legislation that will provide incentive to save for retirement, the so-called Personal Equity and Retirement Account or PERA bill. Apart from encouraging supplementary savings for retirement, this can be an important focus point for harmonized regulation.
Improving pension institutions
Strengthening the financial health of the government pension funds, particularly the Social Security System (SSS), which have the potential for mobilizing large amounts of long-term savings and directing them toward capital market development, is also of key concern.
Next to banks, the pension institutions, mostly government-managed and -guaranteed, are the largest players in the financial market.
Unfortunately, the SSS in the next couple of years will likely become a net taker instead of provider of funds. Unless its actuarial deficiency is corrected by increasing member contributions to match the level of benefits, SSS's financial weakness will aggravate the scarcity of long-term funds and potentially, feed into the problem of fiscal imbalance, exploding public debt, and crowding out of private corporate fund users.
Some thinking needs to be done to revamp basic architecture of pension system since government cannot afford the large accumulated pension liabilities - estimated by a team of consultants to be unsustainable - and will find it politically difficult to secure public acceptance of an increase in contribution rate to close the large gap between contributions and benefits. As noted earlier, over short-term legislation for favorable tax treatment of voluntary personal savings retirement vehicles will help in this regard.
An ambitious medium-term approach would be to institute a nationally defined contribution savings scheme, privately managed and fully portable, to complement a scaled-down, government-run and -guaranteed defined benefit pension system. This will help provide financial institutions and the market with long-term source of savings, estimated at some P32 billion annually based on needed adjustment of SSS's contribution rate from 9.4% to 17% that will in turn help provide long-term funding to corporations.
Solving the pre-need industry's problems
There is also a need to sort out the problem of large pre-need companies experiencing difficulties. The rapid growth of the pre-need sector demonstrated people's ability and willingness to save for the long-term given a good savings product and a delivery system that's culturally attuned to the Filipino community.
The challenge is how not to throw the baby out with the bath water. Government may need to find at least cost way of helping (e.g. special purpose asset vehicle (SPAV)-type fiscal incentives government-organized write downs), if deemed necessary to preserve gains in fostering long-term savings in this form. Down the road, introducing a rating system for pre-need companies may be essential to protect less financially savvy buyers.
Appointing a good regulator
There is likewise a need for a good regulator who does not merely check compliance with a given set of rules and regulations but is also able to attract technically competent downstream sector regulators who have both the confidence of the players and the self-confidence in the correctness of their official acts.
Immunity from suit for regulators, exemption from salary standardization, and ability to retain resources for institutional development may need to be secured. Greater coordination among regulators is being pursued through the newly organized financial regulators forum and should result in avoiding sectors "falling between the cracks," eliminating regulatory arbitrage - the pre-need lesson - and rewards that are not driven by inherent value.
Continuing reforms
Continuing reforms started in improving corporate governance and new legislation to improve functioning of corporate recovery process is also a must. Moreover, there is a need to develop financial infrastructures and conventions to enable efficient securities transaction, and institutions that support capital market development, like credit bureaus, secondary mortgage institutions (which the recently passed Securitization Law will make feasible), title insurance companies, and well-functioning systems of good corporate governance, and corporate recovery.
This is a full plate - more reason why we should start doing the right things soonest.
Friday, July 29, 2005
Fiscal reform beyond VAT
THE FINANCIAL EXECUTIVE
Business World
After much controversy, the VAT law, the centerpiece of fiscal reform advocated by government, academic and business economists as well as multilateral institutions was finally passed. Its passage ignited hopes of finally putting the fiscal problem behind us. (In a twist that surprised financial markets, the Supreme Court issued a TRO under somewhat mysterious circumstances, putting the law's implementation on hold. It is still the market's expectation that the Supreme Court will lift this TRO not too distantly; were it not so, we would have seen markets plummet by much more than what we observed so far.)
The VAT, however, was never intended as a panacea for government's fiscal problems; in economics parlance, it is necessary but not sufficient for fiscal sustainability. Rather it is only part of a package of measures to put government's fiscal position on solid footing - albeit an important one that buys time for government to implement the rest of the reforms and not be trapped in a vicious debt spiral.
The rest of the work involves strengthening institutional capacities to improve fiscal management and put public finances back on a sustainable track - something that was achieved for the first and last time during the Ramos administration. The list is long and many of the needed reforms have been in government's to-do list since way back.
Sadly, inability to push through with these reforms - a reflection of "political fractionalization" or lack of political cohesion in the legislature as discussed in the latest IMF country report - has increasingly weakened the country's public finances (e.g., narrow tax base, compressed spending on basic services, increasing share of debt service in the budget, exposure to off-budget risks and vulnerability to event risk).
The one area where improvements have been noteworthy is tax administration, i.e., plugging tax leakages and raising the stakes of corruption and nondeclaration of income. Over time, the BIR, during Commissioner Willie Parayno and the DoF Revenue Operations Group under Undersecretary Noel Bonoan have been altering the risk-reward equation for both taxpayers and collectors through high profile filing of tax evasion cases and lifestyle checks. Tactics include appealing to famous personalities' patriotism (e.g., published letter to boxer Manny Pacquiao to pay taxes after his most recent international fight), which has the effect of impressing upon the public that it is vigilant in collecting what is due the government.
Systems-driven reforms have also enabled the BIR to exploit information available within itself, such as matching seller's VAT payments to buyer's VAT claims, and run after those that have underpaid or not paid at all. The plan, I gather, is to be able to fully take advantage of information within government, through plain old coordination with data-rich agencies such as Bureau of Customs, Securities and Exchange Commission, Land Transportation Office, Philippine Deposit Insurance Corp., Mines and Geo-Sciences Bureau and to the extent allowed by law, the Bangko Sentral ng Pilipinas. (In the latter case, it may be worthwhile to revisit the bank secrecy law for tax and bank regulation as well as for anti-money laundering purposes.)
Reforms in tax administration are already bearing fruit as seen in growing tax receipts (BIR collections increased 10% last year compared with less than 8% in 2003 and only 1.5% in 2002). In contrast, the pace of reforms on the expenditure side has been slower. One important development is the Procurement Act passed in 2003 intended to increase transparency and achieve budgetary savings. However, implementation suffers from birth pains so it may take a while to reap the full benefits.
Civil service reform is another area. The bureaucracy, with over 1.5 million employees taking up almost a third of the budget is generally perceived to be bloated. Overlapping functions result following each administration's wont to create new divisions and ad hoc bodies for special tasks. Overstaffing is likewise evident especially at lower levels of the bureaucracy. On the other hand, there is also the problem of inability to attract and retain high-quality personnel based on subsistence pay. Political appointments (down to the director level) have not helped as these have led to high turnover in senior positions and weakened institutional memories. Thus, the civil service is characterized by pockets of efficiencies (where good people opt to toil) but on the whole, perceived as inefficient and unmotivated.
Unfortunately, attempts in the past to pass legislation aimed at "reengineering" the bureaucracy have not been successful given its unpopularity political-wise. Unfortunately also, the present administration was not able to take advantage of that rare window of opportunity following last year's elections to undertake civil service reform. Instead, the strategy has been to implement a voluntary retirement program to trim the number of employees and cut down on personnel costs. However, based on similar past programs, the impact may not be that significant and with adverse selection effects (only the talented who can find work in the private sector avail of the retirement program), government may end up worse off.
Another public expenditure reform area relates to government's contingent liabilities, i.e., off-budget guarantees extended by the national government either explicitly, e.g., to public corporations and build-operate-transfer projects or implicitly, e.g., banking system. These obligations can trigger fiscal crises, especially when realized liabilities proved large. Examples of past blowups include the restructuring of the old Central Bank in the early '90s, the recurring rehabilitation of PNB, and most recently, government's absorption of debts of the National Power Corp. (Napocor). With power firm's successful privatization, the risk of further debt assumption may be reduced.
One critical area where reform is urgently needed is the pension system, particularly SSS. The design of the system is such that government, through its guarantee, is effectively subsidizing all the members, rich and poor. This is because even for members who put in the highest monthly contributions, the estimated present value of the benefits they can expect to receive in the future is larger than all their contributions. The benefit-contribution ratio is even larger for those making the minimum contributions (multiple of 7 times). With this structure having persisted through the decades, the implicit public debt associated with the SSS pension obligations alone was estimated at almost P1.5 trillion in 1999 or approximately 50% of GDP. This is much, much larger than any of the past assumed obligations (e.g., Napocor is P200 billion) and does not count yet obligations of the GSIS (for government employees) and RSBS (for the military - already requiring annual budget appropriations in excess of P10 billion annually for several years now).
While the pension debt is for all intents and purposes real (just a timing issue especially if government opts for band-aid solutions such as the 1% increase in contribution rate early last year) and requires that government takes action immediately, there are other contingent liabilities with largely unknown risks. The problem is that no one really knows when and in what area the next crisis will happen (or likely magnitude), especially without a good monitoring system - yet another area where reforms are needed to help government better appreciate and manage the risks it is exposed to.
There are other fiscal reforms that government needs to pursue, especially on the expenditure side. It needs to devolve more functions to local governments to match higher internal revenue allotments. In the case of public corporations, it needs an honest-to-goodness appraisal of which are vital to national interests and which are better sold to the private sector.
Fiscal reform cannot stop with the VAT (now itself "stopped" we hope temporarily), difficult though this may be in the middle of a political tsunami.
Business World
After much controversy, the VAT law, the centerpiece of fiscal reform advocated by government, academic and business economists as well as multilateral institutions was finally passed. Its passage ignited hopes of finally putting the fiscal problem behind us. (In a twist that surprised financial markets, the Supreme Court issued a TRO under somewhat mysterious circumstances, putting the law's implementation on hold. It is still the market's expectation that the Supreme Court will lift this TRO not too distantly; were it not so, we would have seen markets plummet by much more than what we observed so far.)
The VAT, however, was never intended as a panacea for government's fiscal problems; in economics parlance, it is necessary but not sufficient for fiscal sustainability. Rather it is only part of a package of measures to put government's fiscal position on solid footing - albeit an important one that buys time for government to implement the rest of the reforms and not be trapped in a vicious debt spiral.
The rest of the work involves strengthening institutional capacities to improve fiscal management and put public finances back on a sustainable track - something that was achieved for the first and last time during the Ramos administration. The list is long and many of the needed reforms have been in government's to-do list since way back.
Sadly, inability to push through with these reforms - a reflection of "political fractionalization" or lack of political cohesion in the legislature as discussed in the latest IMF country report - has increasingly weakened the country's public finances (e.g., narrow tax base, compressed spending on basic services, increasing share of debt service in the budget, exposure to off-budget risks and vulnerability to event risk).
The one area where improvements have been noteworthy is tax administration, i.e., plugging tax leakages and raising the stakes of corruption and nondeclaration of income. Over time, the BIR, during Commissioner Willie Parayno and the DoF Revenue Operations Group under Undersecretary Noel Bonoan have been altering the risk-reward equation for both taxpayers and collectors through high profile filing of tax evasion cases and lifestyle checks. Tactics include appealing to famous personalities' patriotism (e.g., published letter to boxer Manny Pacquiao to pay taxes after his most recent international fight), which has the effect of impressing upon the public that it is vigilant in collecting what is due the government.
Systems-driven reforms have also enabled the BIR to exploit information available within itself, such as matching seller's VAT payments to buyer's VAT claims, and run after those that have underpaid or not paid at all. The plan, I gather, is to be able to fully take advantage of information within government, through plain old coordination with data-rich agencies such as Bureau of Customs, Securities and Exchange Commission, Land Transportation Office, Philippine Deposit Insurance Corp., Mines and Geo-Sciences Bureau and to the extent allowed by law, the Bangko Sentral ng Pilipinas. (In the latter case, it may be worthwhile to revisit the bank secrecy law for tax and bank regulation as well as for anti-money laundering purposes.)
Reforms in tax administration are already bearing fruit as seen in growing tax receipts (BIR collections increased 10% last year compared with less than 8% in 2003 and only 1.5% in 2002). In contrast, the pace of reforms on the expenditure side has been slower. One important development is the Procurement Act passed in 2003 intended to increase transparency and achieve budgetary savings. However, implementation suffers from birth pains so it may take a while to reap the full benefits.
Civil service reform is another area. The bureaucracy, with over 1.5 million employees taking up almost a third of the budget is generally perceived to be bloated. Overlapping functions result following each administration's wont to create new divisions and ad hoc bodies for special tasks. Overstaffing is likewise evident especially at lower levels of the bureaucracy. On the other hand, there is also the problem of inability to attract and retain high-quality personnel based on subsistence pay. Political appointments (down to the director level) have not helped as these have led to high turnover in senior positions and weakened institutional memories. Thus, the civil service is characterized by pockets of efficiencies (where good people opt to toil) but on the whole, perceived as inefficient and unmotivated.
Unfortunately, attempts in the past to pass legislation aimed at "reengineering" the bureaucracy have not been successful given its unpopularity political-wise. Unfortunately also, the present administration was not able to take advantage of that rare window of opportunity following last year's elections to undertake civil service reform. Instead, the strategy has been to implement a voluntary retirement program to trim the number of employees and cut down on personnel costs. However, based on similar past programs, the impact may not be that significant and with adverse selection effects (only the talented who can find work in the private sector avail of the retirement program), government may end up worse off.
Another public expenditure reform area relates to government's contingent liabilities, i.e., off-budget guarantees extended by the national government either explicitly, e.g., to public corporations and build-operate-transfer projects or implicitly, e.g., banking system. These obligations can trigger fiscal crises, especially when realized liabilities proved large. Examples of past blowups include the restructuring of the old Central Bank in the early '90s, the recurring rehabilitation of PNB, and most recently, government's absorption of debts of the National Power Corp. (Napocor). With power firm's successful privatization, the risk of further debt assumption may be reduced.
One critical area where reform is urgently needed is the pension system, particularly SSS. The design of the system is such that government, through its guarantee, is effectively subsidizing all the members, rich and poor. This is because even for members who put in the highest monthly contributions, the estimated present value of the benefits they can expect to receive in the future is larger than all their contributions. The benefit-contribution ratio is even larger for those making the minimum contributions (multiple of 7 times). With this structure having persisted through the decades, the implicit public debt associated with the SSS pension obligations alone was estimated at almost P1.5 trillion in 1999 or approximately 50% of GDP. This is much, much larger than any of the past assumed obligations (e.g., Napocor is P200 billion) and does not count yet obligations of the GSIS (for government employees) and RSBS (for the military - already requiring annual budget appropriations in excess of P10 billion annually for several years now).
While the pension debt is for all intents and purposes real (just a timing issue especially if government opts for band-aid solutions such as the 1% increase in contribution rate early last year) and requires that government takes action immediately, there are other contingent liabilities with largely unknown risks. The problem is that no one really knows when and in what area the next crisis will happen (or likely magnitude), especially without a good monitoring system - yet another area where reforms are needed to help government better appreciate and manage the risks it is exposed to.
There are other fiscal reforms that government needs to pursue, especially on the expenditure side. It needs to devolve more functions to local governments to match higher internal revenue allotments. In the case of public corporations, it needs an honest-to-goodness appraisal of which are vital to national interests and which are better sold to the private sector.
Fiscal reform cannot stop with the VAT (now itself "stopped" we hope temporarily), difficult though this may be in the middle of a political tsunami.
Tuesday, May 17, 2005
As good as it gets
POINT OF VIEW
Business World
Unlike my good friend Alex Magno who found only "cold comfort" in the VAT measure passed by Congress, I find the final version quite adequate and congratulate our legislators, especially those who made the compromise formula happen. Indeed, this whole VAT episode reaffirms what one wise man once said - politics is the art of the possible.
From where I sit as a wheelchair economist and a former investment biker, the final VAT bill largely achieved what the Executive set out to do.
1. The political formula automatically gets the 2% increase in the VAT rate the moment the Executive finds the conditions laid down by Congress met, i.e., a National Government budget deficit above 1.5% of GDP or VAT effort above 2.8%. Both have already been met, will be met in January 2006, and will likely still be the state of affairs for many years down the road. A six-month delay but without uncertainty that it will happen is no big deal for a structural measure whose impact will be continuing over the long term. In that sense, it is inaccurate to refer to it as standby authority, but really more a directive to the President to implement the law. According to legislators/lawyers I have spoken to, this makes it immune to constitutional challenge.
2. Most exemptions have been plugged, including for power. The exemption provided to airlines and shipping is to be lamented, but in the scheme of things, not material in amounts viewed from a purely fiscal aggregate perspective, setting aside equity and governance issues.
3. I am not enthusiastic about the increase in corporate income tax to 35%. But if this is the price to pay to "sell" the VAT bill, which is expected to bring in P104 billion over a one-year period, to the public, it is an affordable price. What makes it acceptable is the sunset provision, where after a few years, the tax rate actually goes down to 30% from 32%. Thus, this should not discourage potential investments, where time horizon after set up and gestation period is usually longer.
But what explains the market's tepid reaction, as Alex observed? This is what Philip Medalla has to say:
"The main reason the bicameral committee report had a very small impact on the markets
is that the market had correctly anticipated what the legislature eventually produced." (In other words, there would have been a huge drop in the price of ROPs if, contrary to what actually happened, nothing substantial had been produced by the bicameral committee.) Also, the other reason there was little breast thumping (or reactions similar to what happens when a game-winning shot is made a split second before the buzzer) is the fact that what happened once again confirmed that it takes so much time and effort to do the obvious in this country. To use a baseball analogy, our outfielders are so bad that every flyball is an adventure. So even if the last flyball is actually caught, there is the nagging feeling the game will eventually be lost because the next flyball will be dropped or fumbled. This, of course, is a big problem since, as in any baseball game, a great number of flyballs will be hit towards the outfield.
What are the next flyballs? There are many. The most obvious are the infrastructure and education backlogs.
Anton Periquet, on the other hand, has the following view:
"I do not actually think that investors have fully priced in the effects of VAT (otherwise, we should have seen a bit more excitement - imagine, the prospect of halving our national deficit in one year!). It's just that investors today are (a) distracted by bigger, more global events at the moment, and licking their wounds after recent market corrections. In other words, they are not in the mood to play; (b) too cynical about the Philippines (i.e. they will not believe until it is in place and they see the effects). Too many things can go wrong in this country. Our omnipresent courts may still prevent PGMA from acting in January. Or PGMA herself may lose her nerve when the time comes, as the tax increases begin to bite.
Hence, the likely scenario is that the markets gradually discount the positive effects of VAT as time goes by, and as evidence trickles in showing that "it's for real." (Translation: If we believe this is for real, we should be aggressive buyers of our debt and of Philippine stocks.)"
My bottom line verdict: It is as good as it gets! And a lot better than the so-called fiscal program the President unveiled around this time last year without the benefit of much consultation. The VAT bill, no matter how cumbersome and agonizing the process and not fully satisfactory the outcome, is still something to be celebrated. It showed that it was possible for the country to form a national consensus on an important matter of long-term benefit for the country, even where it entailed short-term sacrifice. And for most of us raging incrementalists, we hope this is something we learned from, and something we can replicate in future reform efforts.
Business World
Unlike my good friend Alex Magno who found only "cold comfort" in the VAT measure passed by Congress, I find the final version quite adequate and congratulate our legislators, especially those who made the compromise formula happen. Indeed, this whole VAT episode reaffirms what one wise man once said - politics is the art of the possible.
From where I sit as a wheelchair economist and a former investment biker, the final VAT bill largely achieved what the Executive set out to do.
1. The political formula automatically gets the 2% increase in the VAT rate the moment the Executive finds the conditions laid down by Congress met, i.e., a National Government budget deficit above 1.5% of GDP or VAT effort above 2.8%. Both have already been met, will be met in January 2006, and will likely still be the state of affairs for many years down the road. A six-month delay but without uncertainty that it will happen is no big deal for a structural measure whose impact will be continuing over the long term. In that sense, it is inaccurate to refer to it as standby authority, but really more a directive to the President to implement the law. According to legislators/lawyers I have spoken to, this makes it immune to constitutional challenge.
2. Most exemptions have been plugged, including for power. The exemption provided to airlines and shipping is to be lamented, but in the scheme of things, not material in amounts viewed from a purely fiscal aggregate perspective, setting aside equity and governance issues.
3. I am not enthusiastic about the increase in corporate income tax to 35%. But if this is the price to pay to "sell" the VAT bill, which is expected to bring in P104 billion over a one-year period, to the public, it is an affordable price. What makes it acceptable is the sunset provision, where after a few years, the tax rate actually goes down to 30% from 32%. Thus, this should not discourage potential investments, where time horizon after set up and gestation period is usually longer.
But what explains the market's tepid reaction, as Alex observed? This is what Philip Medalla has to say:
"The main reason the bicameral committee report had a very small impact on the markets
is that the market had correctly anticipated what the legislature eventually produced." (In other words, there would have been a huge drop in the price of ROPs if, contrary to what actually happened, nothing substantial had been produced by the bicameral committee.) Also, the other reason there was little breast thumping (or reactions similar to what happens when a game-winning shot is made a split second before the buzzer) is the fact that what happened once again confirmed that it takes so much time and effort to do the obvious in this country. To use a baseball analogy, our outfielders are so bad that every flyball is an adventure. So even if the last flyball is actually caught, there is the nagging feeling the game will eventually be lost because the next flyball will be dropped or fumbled. This, of course, is a big problem since, as in any baseball game, a great number of flyballs will be hit towards the outfield.
What are the next flyballs? There are many. The most obvious are the infrastructure and education backlogs.
Anton Periquet, on the other hand, has the following view:
"I do not actually think that investors have fully priced in the effects of VAT (otherwise, we should have seen a bit more excitement - imagine, the prospect of halving our national deficit in one year!). It's just that investors today are (a) distracted by bigger, more global events at the moment, and licking their wounds after recent market corrections. In other words, they are not in the mood to play; (b) too cynical about the Philippines (i.e. they will not believe until it is in place and they see the effects). Too many things can go wrong in this country. Our omnipresent courts may still prevent PGMA from acting in January. Or PGMA herself may lose her nerve when the time comes, as the tax increases begin to bite.
Hence, the likely scenario is that the markets gradually discount the positive effects of VAT as time goes by, and as evidence trickles in showing that "it's for real." (Translation: If we believe this is for real, we should be aggressive buyers of our debt and of Philippine stocks.)"
My bottom line verdict: It is as good as it gets! And a lot better than the so-called fiscal program the President unveiled around this time last year without the benefit of much consultation. The VAT bill, no matter how cumbersome and agonizing the process and not fully satisfactory the outcome, is still something to be celebrated. It showed that it was possible for the country to form a national consensus on an important matter of long-term benefit for the country, even where it entailed short-term sacrifice. And for most of us raging incrementalists, we hope this is something we learned from, and something we can replicate in future reform efforts.
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