A PPP success story

Business World
Introspective

Public Private Partnership (PPP) has been launched recently as a key ingredient in the administration's program to address infrastructure needs, raise investment levels, and build a broader base for sustainable growth, while attending to the country's fiscal constraints.

Earlier called BOT (and its variants), PPP was used effectively by President Ramos and his team to address in record time the power and water crises in the 1990s, demonstrating political will and effective management. As a Finance undersecretary at the time, I was privileged to have worked with Energy Secretary Del Lazaro, drafted from a distinguished career in the private sector to put the lights back on, as well as with MWSS Administrator Lito Lazaro, a Princeton PhD civil engineer and coincidentally Del's brother, to bring water to the people.

During the succeeding two administrations, interest in PPP waned markedly. The decline in the number of PPP projects, as well as the amounts invested in them, mirrored the decline in the investment to GDP ratio - from an average of 25% during the Ramos administration to only 15% during Arroyo's. The 1997 Asian financial crisis and controversies that hounded a few high profile projects (e.g., PIATCO) contributed to this steep drop, but I think the real binding constraint has been the well- documented deterioration in indicators of governance and regulatory environment over the past decade. Hopes are therefore high that the P-Noy administration, having been elected on a good governance platform, enjoying an unprecedented trust rating, and possessing a strong economic team, can relieve this constraint, and reinvigorate investor interest in PPP.

As encouragement for the way forward, let me share the success story of the MWSS PPP. This is a story I am familiar with as I was Finance Secretary de Ocampo's representative in the MWSS board to track the privatization. I also wrote a paper on it for the World Bank, and later on, was an occasional adviser to one of the concessionaires.

What prompted the MWSS privatization in the mid 1990s? Very poor service delivery seen as a water crisis. Only two thirds of Metro Manila were connected to MWSS water pipes. Most customers were subject to water rationing with less than 3 out of 10 having 24-hour supply, and worse, occasional outbreaks of cholera cases were a growing concern. Moreover, MWSS had become a major fiscal burden with debt in excess of a billion dollars. It found itself in a Catch-22: no resources to expand the system and improve its very poor service delivery, but unable to politically justify raising water rates needed to raise resources. Moreover, it was encumbered by government bureaucratic inertia, processes, and vested interests, both within and without. Privatization, which had worked well elsewhere, was seen as a logical way out.

Through the exercise of political will and judicious haste, the complex preparatory technical, economic, legal, and political management process from conception to final award of the largest privatization anywhere was completed in less than two years. It was done in a most transparent competitive bidding process overseen by the World Bank/IFC and participated in by four established Philippine conglomerates in joint venture with international utilities firms.

This process and the long story up to the present is told in a paper on the Political Economy of Reform During the Ramos Administration 
(http://www.growthcommission.org/storage/cgdev/documents/gcwp039web.pdf ) which Christine Tang and I wrote for the World Bank's Growth Commission. This story is punctuated by the financial failure of the Maynilad west zone concession after the Asian financial crisis, and transfer of the Maynilad concession to the Metro Pacific group in 2007 following a competitive bidding process. This was an event which analysts saw as proof of the robustness of the privatization design and the political will of the government to persevere with the PPP path.

Notwithstanding the hiccups and the regulatory learning along the way, and based primarily on the record of Manila Water, this PPP story can be judged an outstanding success. The success of Manila Water, moreover, provides an easy road map for the new Maynilad to replicate for the west zone in good time.
What is the success record of Manila Water? The numbers tell all. Non- revenue water was reduced from 63% in 1997 to just 12.5% at present. As a result, without taxpayer money being spent for new water sources, the amount of delivered water to customers grew threefold from 440 million liters per day to 1,140 million. From serving only 3 million customers, it now serves 6 million, practically all of whom get 24-hour service, from just 30% before privatization. Most notably, through an innovative community service scheme, it now provides continuous piped water to 1.7 million people in marginalized communities at a cost of less than P75 per month, when in the past they would have had to buy vended water at P 150- 200 per cubic meter.

All this was achieved by the investment of over a billion dollars in the system, sourced not from the public purse as would have been the case pre-privatization, but from investors, commercial lenders and official development loan providers who believed in the company. Manila Water, a profitable listed company with 45% of its shares in public hands, has received numerous global awards for operating efficiently and bringing water to the urban poor.

Manila Water's ability to improve and expand service, and access funding efficiently without any government guarantees is likewise testament to a functioning regulation by contract framework.

Save for a few months in 2009, when the contractually agreed upon automatic adjustment in tariffs was suspended for what seemed like political reasons, regulation by contract has worked rather well.

This framework includes a regular rate rebasing exercise once every five years, subject to wide and intense public scrutiny and hearings. During an early rebasing, key performance indicators and business efficiency measures were introduced to mimic a competitive market.

Credit for effective regulation is owed to an independent Regulatory Office of MWSS and the technical assistance it has been able to access, notably from UP professors led by Dr. Philip Medalla.

The oversight agencies, the Department of Finance and NEDA, have likewise played important roles in maintaining the integrity of the concession agreement.

Finally, it has helped that there was never any interference from politicians in the rate setting, and that there is a dispute settlement process incorporated in the concession agreement involving international arbitration, a safeguard that has been tested successfully twice.

There are key lessons from this PPP success story: the importance of political will and judicious haste, the value of competitive award processes and good use of expert technical assistance, the need to uphold the integrity of concession contracts, ensure their proper implementation and insulate PPPs from toxic politics.
For the P-Noy administration, keeping to such a course for its PPP program should help it deliver on its promise to bring our country to a higher growth path and improve peoples' lives.


Mr. Romeo Bernardo is managing director of Lazaro Bernardo Tiu & Associates, Inc. (a consultancy firm), board member of The Institute for Development and Econometric Analysis, Inc, and was undersecretary of Finance during the Aquino1 and Ramos administrations.For comments and inquiries, please e-mail us at idea.introspective@gmail.com.

"A PPP success story"

Business World, Introspective

Public Private Partnership (PPP) has been launched recently as a key ingredient in the administration's program to address infrastructure needs, raise investment levels, and build a broader base for sustainable growth, while attending to the country's fiscal constraints.

Earlier called BOT (and its variants), PPP was used effectively by President Ramos and his team to address in record time the power and water crises in the 1990s, demonstrating political will and effective management. As a Finance undersecretary at the time, I was privileged to have worked with Energy Secretary Del Lazaro, drafted from a distinguished career in the private sector to put the lights back on, as well as with MWSS Administrator Lito Lazaro, a Princeton PhD civil engineer and coincidentally Del's brother, to bring water to the people.

During the succeeding two administrations, interest in PPP waned markedly. The decline in the number of PPP projects, as well as the amounts invested in them, mirrored the decline in the investment to GDP ratio - from an average of 25% during the Ramos administration to only 15% during Arroyo's. The 1997 Asian financial crisis and controversies that hounded a few high profile projects (e.g., PIATCO) contributed to this steep drop, but I think the real binding constraint has been the well- documented deterioration in indicators of governance and regulatory environment over the past decade. Hopes are therefore high that the P-Noy administration, having been elected on a good governance platform, enjoying an unprecedented trust rating, and possessing a strong economic team, can relieve this constraint, and reinvigorate investor interest in PPP.

As encouragement for the way forward, let me share the success story of the MWSS PPP. This is a story I am familiar with as I was Finance Secretary de Ocampo's representative in the MWSS board to track the privatization. I also wrote a paper on it for the World Bank, and later on, was an occasional adviser to one of the concessionaires.

What prompted the MWSS privatization in the mid 1990s? Very poor service delivery seen as a water crisis. Only two thirds of Metro Manila were connected to MWSS water pipes. Most customers were subject to water rationing with less than 3 out of 10 having 24-hour supply, and worse, occasional outbreaks of cholera cases were a growing concern. Moreover, MWSS had become a major fiscal burden with debt in excess of a billion dollars. It found itself in a Catch-22: no resources to expand the system and improve its very poor service delivery, but unable to politically justify raising water rates needed to raise resources. Moreover, it was encumbered by government bureaucratic inertia, processes, and vested interests, both within and without. Privatization, which had worked well elsewhere, was seen as a logical way out.

Through the exercise of political will and judicious haste, the complex preparatory technical, economic, legal, and political management process from conception to final award of the largest privatization anywhere was completed in less than two years. It was done in a most transparent competitive bidding process overseen by the World Bank/IFC and participated in by four established Philippine conglomerates in joint venture with international utilities firms.

This process and the long story up to the present is told in a paper on the Political Economy of Reform During the Ramos Administration (http://www.growthcommission.org/storage/cgdev/documents/gcwp039web.pdf ) which Christine Tang and I wrote for the World Bank's Growth Commission. This story is punctuated by the financial failure of the Maynilad west zone concession after the Asian financial crisis, and transfer of the Maynilad concession to the Metro Pacific group in 2007 following a competitive bidding process. This was an event which analysts saw as proof of the robustness of the privatization design and the political will of the government to persevere with the PPP path.

Notwithstanding the hiccups and the regulatory learning along the way, and based primarily on the record of Manila Water, this PPP story can be judged an outstanding success. The success of Manila Water, moreover, provides an easy road map for the new Maynilad to replicate for the west zone in good time.

What is the success record of Manila Water? The numbers tell all. Non- revenue water was reduced from 63% in 1997 to just 12.5% at present. As a result, without taxpayer money being spent for new water sources, the amount of delivered water to customers grew threefold from 440 million liters per day to 1,140 million. From serving only 3 million customers, it now serves 6 million, practically all of whom get 24-hour service, from just 30% before privatization. Most notably, through an innovative community service scheme, it now provides continuous piped water to 1.7 million people in marginalized communities at a cost of less than P75 per month, when in the past they would have had to buy vended water at P 150- 200 per cubic meter.

All this was achieved by the investment of over a billion dollars in the system, sourced not from the public purse as would have been the case pre-privatization, but from investors, commercial lenders and official development loan providers who believed in the company. Manila Water, a profitable listed company with 45% of its shares in public hands, has received numerous global awards for operating efficiently and bringing water to the urban poor.

Manila Water's ability to improve and expand service, and access funding efficiently without any government guarantees is likewise testament to a functioning regulation by contract framework.

Save for a few months in 2009, when the contractually agreed upon automatic adjustment in tariffs was suspended for what seemed like political reasons, regulation by contract has worked rather well.

This framework includes a regular rate rebasing exercise once every five years, subject to wide and intense public scrutiny and hearings. During an early rebasing, key performance indicators and business efficiency measures were introduced to mimic a competitive market.

Credit for effective regulation is owed to an independent Regulatory Office of MWSS and the technical assistance it has been able to access, notably from UP professors led by Dr. Philip Medalla.

The oversight agencies, the Department of Finance and NEDA, have likewise played important roles in maintaining the integrity of the concession agreement.

Finally, it has helped that there was never any interference from politicians in the rate setting, and that there is a dispute settlement process incorporated in the concession agreement involving international arbitration, a safeguard that has been tested successfully twice.

There are key lessons from this PPP success story: the importance of political will and judicious haste, the value of competitive award processes and good use of expert technical assistance, the need to uphold the integrity of concession contracts, ensure their proper implementation and insulate PPPs from toxic politics.

For the P-Noy administration, keeping to such a course for its PPP program should help it deliver on its promise to bring our country to a higher growth path and improve peoples' lives.

Taxing matters

Business World 
Introspective

The Bureau of Internal Revenue has posted in its Web page the list of its top 500 individual taxpayers. It is unclear to me what public purpose is achieved by posting such a list. What is clear is that it may have caused unfair and unnecessary unease for both those on and out of the list.

For those on the list, continuing public Web page access to the information is cause for worry that this provides easy reference for every donation seeker, scam artist, or even worse.

Those affluent but absent were not spared, for most undeservedly, as the list provided fodder for gratuitous speculation. One broadsheet asked provocatively in its front page why this or that prominent top executive or businessman was not on the large taxpayer list; as did at least one priest's Sunday sermon I heard about.
There can be several reasons why one who is rich or earning well may not appear on the list, none having anything to do with lack of fidelity in paying one's taxes. For many top executives, the company withholds and pays their individual income taxes directly to the BIR under a procedure known as substituted filing. 
Provided the individual has only that single source of still taxable income, he does not need to file an income tax return. These substituted filings were likely not captured by the BIR's top 500 list.

Then there are cases of individuals who have incorporated their business, such that the income is earned by the corporation, which then pays the appropriate corporate income taxes. Additionally, the dividend income the individual derives from the corporation is levied a final tax collected at source. There is no requirement that this be subject of an individual income tax filing. This is true as well for those whose income is passive, i.e., derived primarily from interest and dividends, which are imposed final taxes withheld at source. These are not captured in BIR's top 500.
These limitations in the data were not adequately explained by the BIR, either in their post or in public pronouncements. Thus rather than shaming tax evaders which may have been the object of the top 500 exercise, the issuance of such a list without qualification may have just provoked people to unfairly rail against those prominently known but absent from the list but who are already in BIR's tax net and faithfully paying their taxes.

One has to question the wisdom of continuing with such a list, which achieves no apparent public purpose, but just puts listed large individual taxpayers at risk from criminal elements, and unlisted law- abiding ones at risk of unfair shaming by the uninformed. If the BIR insists on continuing with this practice, the least it can do is to remove the amount of taxes paid in the interest of safety of the taxpayer and his family. For my part, I truly doubt that the large tax evaders and smugglers, who are completely outside the tax agencies' data base as they do not issue receipts or file returns, can be shamed into paying proper taxes. The current leadership truly needs to break away from the past practice of simply hunting in the zoo and go after voracious wildlife - not an easy tax at all.

To be fair, the new leadership in the DoF and the BIR is demonstrating amazingly admirable determination to raise revenue collections through various programs. I applaud them vigorously. Their work is made difficult by structural erosion in the revenue base due to non-indexation of excise taxes, as well as the passage of tax-eroding laws in the last two years, by one estimate costing over 1 % of GDP annually (P80 billion). 

Administrative measures, however, can only do so much, based on both our own and international experience. It does not help that the new administration came in under a campaign promise of no new or increase in taxes even as it is under pressure to do catch-up infrastructure and social spending.

Perhaps in an effort to help increase revenues while staying faithful to the administration campaign promise, Rep. Dodong Mandanas, chairman of the House Ways and Means Committee is pushing hard for a Value Simplified Tax ( VAST) at 6% to replace the 12% VAT. Despite opposition from the Department of Finance and known experts in the field, this has recently passed his committee. I share the reservations of critics of VAST, a multi-stage turnover tax that cascades, i.e., imposed on a product several times depending on the number of stages involved throughout the production and distribution chain. As the DoF position paper states: adopting a lower rate of 6 % for VAST can be deceiving and the poor who is largely limited to purchasing goods from a retail store could end up paying more than the rich. The paper also argues persuasively that in addition to being not transparent (which could actually be its major selling point) it distorts production and resource allocation, as well as impacting unfavorably on exports. (The public can derive comfort from the pronouncements of Senate Ways and Means Committee Chairman Sen. Ralph Recto that he does not favor the VAST for the reasons cited. )

If not VAST, what then to improve the fiscal picture and finance needed development spending? UP Professors Canlas, Diokno, and Medalla, in a fiscal road map, they drew up before the presidential elections, put forward the following measures: a) reform of fiscal incentives, b) reform of excise taxes on cigarettes and liquor, c) increase in VAT to 15 % while lowering personal and corporate income taxes to 25%, d) a higher taxes on fuel products. (See my column, Fiscal imperative for next administration, Oct 5, 2009)

Even as the fiscal leadership perseveres in trying to collect more from the existing tax base, it should perhaps quietly constitute an experts study group to do a comprehensive review of our tax system and recommend reforms adapted to changing complexion of the Philippine economy and its financing needs.

Mr. Romeo Bernardo is managing director of Lazaro Bernardo Tiu & Associates, Inc. (a consultancy firm), board member of The Institute for Development and Econometric Analysis, Inc, and was undersecretary of Finance during the Aquino1 and Ramos administrations.

Did peace bonds disadvantage gov't?

Business World
Introspective

The Peace Bonds have become a live issue again with the 10-year bonds maturing early next year. The analysis (below) of the Foundation for Economic Freedom in 2002 came to the conclusion that taxpayers were not disadvantaged. This paper is an abridged version of what was drafted by former FEF President Francis Varela, FEF Chairman Philip Medalla, and myself.

Critics have alleged that there was an anomaly involved in the sale of the P1.4-billion Peace Bonds, allowing CODE-NGO to generate a fantastic windfall and leading to significant losses on the part of government. To our mind, the key question toward developing a dispassionate and rational perspective on the whole issue is:
What was the appropriate value of these bonds when they were issued in October last year?

First, the pertinent facts:
The Bureau of Treasury sold (through a bidding process) 10-year zero- coupon bonds with a face value of P35 billion to a bank (RCBC) which acted on behalf of CODE-NGO. The bonds were sold at a total price of P10.2 billion, thus implying a yield of 12.75% per annum. The bonds are effectively tax exempt and eligible as liquidity reserves for banks and quasi-banking institutions. Simultaneously, or within a very short period of time, CODE-NGO sold the bonds to RCBC Capital at a gross profit of P1.8 billion or a total consideration of P12.0 billion. At this price, the implied yield of the bonds to the end-buyer (RCBC Capital) goes down from 12.75% to only 11 percent.

Was the appropriate value of the bonds upon issuance P10.2 billion or P12.0 billion? Or, alternatively, was the appropriate yield of the bonds 12.75% or 11%?

We have to note that the difference between the two yields is very significant and non-trivial in a reasonably efficient financial market. Thus, if this wide a yield movement takes place without the occurrence of a major market-shaking event, then the conclusion is that either the issuer paid too high a yield or the final buyer overpaid for the bond and is now suffering below-market yields. As the Philippine financial market was relatively calm when the Peace Bonds were auctioned, clearly, therefore, one of the yields was wrong.

If 11% was indeed the appropriate yield for the bonds, then the Department of Finance/Bureau of Treasury committed a serious mistake in the sale of the bonds and were remiss in their duty to protect the interests of government. Notwithstanding the openness of the auction and without having to allege that it was rigged, one could nevertheless argue that they should have devoted more time and effort explaining the features of the bond to more market participants in order to achieve the lower yield. If this were the case, then the critics are right and we, as taxpayers, should all join in condemning the issue as a major anomaly.

On the other hand, if the appropriate yield of the bonds was 12.75%, then clearly there could have been no anomaly involving government funds and the only logical conclusion is that RCBC overpaid for the bonds, and the extraordinary profit enjoyed by CODE-NGO could not have come from government.
We now proceed to analyze the features of the bond to determine its appropriate value. First, we would like to note that the main features that enhanced the value of the bond were the tax exemption and the liquidity reserve eligibility. Second, we also wish to note that the zero-coupon feature did not add any value to the bond. Normally, a zero-coupon bond issued by the same issuer and with the same tenor would trade at a slightly higher yield than an ordinary coupon-bearing bond.

Thus, conservatively (from the issuer's standpoint) we can compare the Peace Bonds with the regular 10-year Treasury note. At the time of the auction, the regular 10-year T-notes were trading in the secondary market at a yield of 16.9%. Since the regular 10-year T-note is subject to the 20% final withholding tax, the after-tax yield of the 10- year T-note was 13.5%. Thus, if the Peace Bonds had no other enhancement aside from the tax exemption, then it should have traded at around 13.5% or higher, not 12.75% and DEFINITELY NOT 11%. On the other hand, considering that the difference between the regular T-bills and the reserve eligible ones is only 0.5%, then the fair yield of the Peace Bonds was approximately 13%.

Based on the foregoing, it is our conclusion that the 12.75% original yield of the Peace Bonds was favorable to government and that it was RCBC, not government, that bore the cost of the P1.8-billion windfall that was enjoyed by CODE-NGO by suffering an inordinately low yield on this instrument when they bought the bonds on a secondary basis from CODE-NGO. Whether this resulted from philanthropy and social spirit, miscalculation or contractual constraints that required RCBC to provide fees to CODE-NGO even in a transparently bid auction where they would have been entitled to participate anyhow, or a combination of the above, is a private matter.

Now, looking at this issue in its entirety, we believe that it was inappropriate, if not outright wrong, for CODE-NGO to have attempted to conduct this transaction on a negotiated basis, as they themselves have admitted. We believe it is fair to surmise that, if there was no auction, the government would have ended having to bear the cost of the CODE-NGO windfall. Thus, instead of being pilloried and maligned, the DOF and the BTr deserve our congratulations and commendation for having resisted the strong overtures of CODE-NGO to conduct a negotiated sale. In particular, we have to thank Treasurer Sergio Edeza for having been so clear and unswerving in his position on the matter, and for taking only the highest interest of the Republic into account in his actions. Clearly, the government did not lose a single centavo in the transaction, thanks to their efforts.

Mr. Romeo Bernardo is Global Source Philippine advisor and board member of The Institute for Development and Econometric Analysis, Inc. He was formerly undersecretary of Finance during the Aquino and Ramos administrations.

Coping with surges: Unlikely controls

Business World
Introspective

In the current scenario, with low forecast inflation, we are more convinced that monetary authorities will refrain from hiking policy rates until the end of the year because this could encourage further speculative flows. We believe, however, that it is highly unlikely that they will turn to capital controls despite Asian neighbors doing so except as a last resort.

There are several reasons behind the latter view. One is the BSP's consistent behavior in recent history as it allowed the exchange rate to appreciate sharply in the face of strong dollar flows. The last such episode had only been a couple of years ago when the peso was allowed to rise in value dramatically from near P50/$ in 2007 to about P40/$ by early 2008 citing a mandate to limit exchange rate volatility but not dictate trend.

Another is the belief of monetary authorities as reflected in a recently updated primer that such measures are costly to implement and likely ineffective in the long run as ways to circumvent them can be found. Past experience of the country with controls had not been pleasant (i.e., on FX, for most periods between the 1950s until 1992), as these had been difficult to administer and prone to abuse.

An aversion to capital controls remains, with the central bank fearing that re-imposition of barriers would discourage investors, weaken access to international capital markets, and hinder the ability to attract foreign investments. Not too long ago, in December 2006, fellow inflation targeter Thailand effectively taxed foreign portfolio investors by requiring unremunerated reserves, a policy move that led to a surge in stock volatility and a 15% fall in Thai equities in a single day. (N.B. This was reimposed a couple of days ago.)

Monetary policy makers typically argue that remittances and export receipts dominate foreign exchange inflows such that peso movements had fundamental basis, voiding the issue of currency overvaluation. While it is known that even fundamentally sound flows can precipitate asset booms and busts in certain sectors, they aver that peaks seen today in the local equities market hardly constitute a bubble. In the real estate sector, there is also no rapid escalation of prices so far with demand coming mostly from end-users, mainly overseas workers' families; with transactions involving contracts to sell rather than contracts of sale, meaning the property remains in the name of the seller until fully paid; and with the institutional financing setup discouraging excessive risk taking.

Other solutions to prevent the collateral impact of large capital flows are being offered by the BSP such as the use of macro-prudential regulations to prevent bubbles and administrative measures to encourage FX outflows. In addition, Mr. Guinigundo said the BSP can carefully calibrate monetary policy, balancing the need to tighten liquidity and reduce risk appetite to short an otherwise full bubble situation against the possibility of higher interest rates further attracting hot money.

To appease dollar earners who were hurting from a strong peso in 2007, steps then taken by the central bank included retiring external debt, encouraging national government to alter its financing mix or prepay debt, and liberalizing the foreign exchange system (e.g., allowing banks to take a larger overbought position) apart from some accumulation of reserves, including FX swaps. Such measures will likely be again pushed if peso strength persists.

This column was taken from the Oct. 1 report of the author and Margarita D. Gonzales. Both are advisors of GlobalSource, a New York-based network of independent analysts. Mr. Bernardo is also a board director of IDEA, the Institute for Development and Econometric Analysis.

Coping with surges

Business World
Introspective

While hot money has been flowing heavily into emerging market economies this year, it was only in the last couple of weeks that the Philippines started to feel a surge in capital. Now at the front end of the receiving line, the relatively small Philippine Stock Exchange has become the second-best performer in Asia, with the main index (the PSEi) already surpassing its peak in 2007 and, much earlier than foreseen, broken the critical 4000 mark by mid-September.

Strong demand has been fueled in large measure by foreign buying as abundant global liquidity due to quantitative easing in advanced economies naturally sought higher returns in emerging markets. The optimism has also been partly due to a surprisingly buoyant domestic economy and, to some extent, a new leadership after a period of uncertainty lowering political risk.

Apart from equities, foreign money has also flowed into government paper lured by interest differentials, where registered portfolio investment in peso securities grew by 38% in the first half to nearly $1 billion. The country's first global peso issue early in September likewise served as a magnet for funds, bringing in another $1 billion equivalent. Just a few days ago, the government swapped existing Philippine global bonds (ROPs) with securities of later maturity that were either reopened or newly minted, with the new issuances also sold for cash (about $200 million).

The result of these forces has been an even stronger peso, with the exchange rate now falling below P44/$. Unless another major downturn occurs in the world economy or the domestic fiscal situation gets out of hand, peso appreciation can be expected to continue and, in our view, drop to about P43/$ by yearend.

Assets denominated in local currency may remain attractive owing to continued strength of overseas Filipinos' remittances and a still rapidly rising export haul of BPO firms providing support to the peso. Despite a steep trajectory in stock prices, there remains room for improvement as the local bourse's price-earnings ratio still lies at the middle of the range historically and compared with other bourses in the region while forecasts of corporate profitability remain high.

To fund the national deficit, the government is expected to issue more global peso bonds which have proven to be attractive to foreign investors compared with domestic peso issuances because of ease of trading, absence of withholding taxes and offshore dollar settlement. Meanwhile, global capital moving away from advanced markets may go on combing through emerging markets for higher profit potentials.

'Complications'

As global capital has funneled into emerging markets, capital controls have suddenly become respectable, especially with the IMF lately acknowledging that such measures can be a legitimate part of the tool kit to manage capital inflows under certain circumstances. Asian economies that have experimented with controls include South Korea, which placed limits on the buildup of FX derivatives last June to reduce the risk of capital reversals, and Indonesia, which adopted measures at about the same time to discourage short-term fixed-income investment.

With risk appetites seemingly back after waning temporarily due to the euro zone sovereign debt crisis, some of the hot money flows has now also headed the way of the Philippines. After the US Fed announced last week that it was keeping the Fed's fund rate close to zero, Bangko Sentral ng Pilipinas (BSP) Governor Amando Tetangco said monetary authorities were aware that interest differentials remained in favor of emerging market economies and acknowledged that this could complicate monetary policy.

While the Philippines had already shifted to inflation targeting given the futility of trying to manage the exchange rate while simultaneously controlling domestic liquidity, difficulties remain in dealing with large capital flows, particularly given the negative impact of a strong peso on exporters and overseas workers' families. The BSP still has to walk a fine line between smoothing fluctuations in the exchange rate and keeping inflation within target.

In an e-mail exchange, Deputy Governor Diwa Guinigundo shared with us that while a sustained capital surge could lead to excessive liquidity creating inflationary pressure and asset price bubbles, the BSP was not overly concerned because the magnitude remains manageable. He believes inflows have even helped the central bank manage inflation by supporting peso appreciation, while low inflation helped partially restore competitiveness.

Beyond 'obscene' GOCC compensation

Business World
Introspective

Much media space and Congress energies have been devoted to the scandalously high compensation provided by the Arroyo administration to its officials in some GOCCs, especially for those in corporations perceived to have performed poorly like the SONA-mention-worthy MWSS.

While such indignation is not misplaced, such wastes are perhaps in most cases dwarfed by social and economic costs to the country of poor governance due to poorly defined missions, political interventions, corruption, and incompetence.

I would put under that category, NFA, which, even if it has not been an overly generous employer relative to others we read about in the papers, managed to lose P 100 billion in two years while achieving little.
According to a World Bank study, for every P5 of subsidy that the taxpayer pays, only P1 is realized as having social benefit, and the balance, just wasted, or diverted.

Many of us, I think, will be quite happy to pay Singapore-level compensation for GOCCs, if they can perform like Singapore public entities. Thus, I have absolutely no qualms about what some may see as relatively high pay of management of the BSP, an institution which has earned the respect of both international and financial community as being in its own class in this country.

So, the point to underscore beyond the headlines of obscene compensation is performance. In fact, in the case of the BSP, its financial independence and good-pay structure is perhaps part of the story behind good-governance structures, one that allows the recruitment and retention of good people, and the development of a cadre of professionals with a long-term commitment to their organization's well-defined mission under its charter (and who are continuously challenged by financial stresses both local and global).

Clearly though, pay is only part of the story. The other elements of its good-governance story include historical good leadership, a well- defined mandate, having an incentive structure in the organization that is aligned with its mission and insulated from bad politics and conducive to adopting best practices of like institutions globally.

The other government corporations under public klieg lights in terms of pay are GFIs, especially the two pension institutions - SSS and GSIS. In 2006, I had the privilege of being part of a team of international consultants commissioned by the World Bank and the Department of Finance to look at the structural and governance weaknesses of government pension institutions so that they can perform better. (The team included Estelle James, a well-known expert and author of a standard reference on the subject: Averting the Old Age Crisis: Policies to Protect the Old and Promote Growth)

The cost to the economy of their poor performance manifests in the risks they pose to the fiscal sector, since pension benefit liabilities are guaranteed by the national government. We have only to remember the bad investments that GSIS made in the 1970s in many enterprises (like PAL, Manila Hotel, etc.) that ended up being loaded on the Department of Finance auction block and the bankruptcy of RSBS and the resultant reversion of all of the pension-servicing responsibilities of the military back to the national government a few years ago. And who can forget the documented involvement in stock-market manipulation that was part of the charges that led to the impeachment of President Estrada? Eyebrows were raised as well by their participation in high-profile corporate boardroom struggles as well as general concern that these two heavyweights, in playing the stock market, were a cause of major distortions. Most recently we were dismayed by reported huge investments of Home Development Fund/Pag-ibig, in questionable mortgage papers of a development company that they have recently blacklisted, in what seems like a case of shutting the barn door after the horses have bolted.

Our final report, almost 200 pages without annexes, was submitted to the sponsors in March 2007, and may be available upon request.

Allow me to list just a few its key recommendations:
1. Governance institutions need to be strengthened: Members of the SSS Commission, GSIS Board of Trustees should have clear fiduciary responsibility to make decisions solely in the interest of members, and should be chosen through a selection process that ensures professionalism and protection from political interference. (Rural bank directors have to be vetted by the BSP to be fit and proper, but not these pension institutions.) A professional Investment Board should be formed for each institution, to take specific investment decision under the broad investment strategy set by the governing board.

2. Investment processes should be strengthened through the adoption of explicit investment policies that set objectives regarding returns, risk management, types of assets to guide specific investment decisions. Institutions should solicit outside professional investment advice and independent asset managers and custodians should be used.

3. Investment portfolios should be better diversified, including internationally to go beyond the relatively small Philippine capital markets. Domestically, equity investments should be shifted toward pooled instruments such as an allocation matching the Philippine Stock market index, thereby reducing influence on specific share prices and avoiding the need to place members in corporate board of directors.

4. Supervision should be unified and strengthened. A new Insurance and Pension Commission, built on the foundation of the current Insurance Commission, should supervise SSS. GSIS, Pag-ibig, all private pension schemes and any similar instruments.

5. The government should consider the merits of a universal or needs- based pension, paid from general state revenues, to complement existing pension programs, in order to expand coverage and reduce elderly poverty.

6. Pension reform needs to fit into a context of overall financial sector development.

The new leadership in these institutions as well as in the Department of Finance should take a look at how they can address the governance and structural weaknesses in these institutions in a lasting manner.

Mr. Romeo Bernardo is managing director of Lazaro Bernardo Tiu & Associates, Inc. (a consultancy firm), board member of The Institute for Development and Econometric Analysis, Inc, and was undersecretary of Finance during the Aquino 1 and Ramos administrations.