Do we have a future in manufacturing?

Business World
Introspective

Secretary Greg Domingo of the Department of Trade and Industry (DTI) and his team deserve congratulations for the long-awaited automotive industry roadmap, most aptly named CARS (Comprehensive Automotive Resurgence Strategy Program). This was the subject of a recent consultation meeting of the DTI with an “Eminent Persons Group” to get advise on the new industrial policy thrust of the government.

CARS represents several years of hard work of Undersecretary Che Cristobal and Assistant Secretary Fita Aldaba, who is also senior fellow and vice-president of the government think tank the Philippine Institute for Development Studies. They painstakingly crafted a plan and forged a difficult consensus -- especially with the Department of Finance -- on a new thinking on an industrial policy that involves government support for a program that is well-targeted, time-bound and performance-based.
The search for a national pathway to create quality jobs that will absorb almost a million new entrants in the labor market and the 11 million who are unemployed and underemployed was also the topic of a recent experts roundtable chaired by National Economic and Development Authority Secretary Arsi Baliscan. A most interesting presentation came from Asian Development Bank adviser Jesus Felipe.

Based on his study of more than 100 economies over time, he suggested that for the Philippines, the long-term challenge was not how to ignite growth, but rather how to become a modern industrial service economy. According to him, this would need economic transformation, including pushing into niches that foster “structural transformation, innovation and entrepreneurship” in close partnership with willing and able private sector. He argued that manufacturing continues to be important today despite the rise in services -- as engine of growth (economies of scale, technical progress, and learning) and as an “escalator” sector (high-productivity catch-up). The DTI’s CARS is driving in the same direction.

A few economist friends are skeptical that a government unable to collect garbage or enforce traffic laws properly can do industrial policy right. For example, National Scientist Raul Fabella, in his column last week, wrote that the government ought to “economize on limited government capacity,” focusing on its role as enabler, such as in providing required infrastructure, a role it has failed across administrations (“Of CALAX, industrial policy and the nature of the State,” June 29).

I am more confident. We can afford experimental interventions as long as public financial exposure is calibrated, there is a clear path to realizing the program’s objectives, and with the right private partners. Just like public-private partnerships in infrastructure where there have been notable successes.

Moreover, the timing is right. With progress in forging an ASEAN Economic Community, major foreign direct investors keen to participate in a growing ASEAN middle-class market are looking for new investment sites in the region, in one case in partnership with an established local conglomerate. I wonder however if CARS as designed can entice new entrants that can drive structural transformation of the kind Dr. Felipe discussed. It seems aimed primarily at the incumbent assemblers, as the barriers to entry are too high for a new participant to satisfy the conditions. (I gather the initial feedback even from incumbent assemblers is that conditions are too steep, given that their current run rates and regional production strategies are already well established.)
It may be time to consider a more fundamental change in the overall regulatory framework of the Motor Vehicle Development Program, a three-decade-old program, so that players with newer technologies and platforms can come in. Perhaps rather than stipulating processes, technologies and business conditions, it should allow for greater leeway in meeting its objectives?

For example, Executive Order 158 specifies painting and welding as necessary activities to qualify -- even when many firms have already moved to global production processes not bundled this way. Should there not be more flexibility that also takes into account already revealed
Philippine comparative advantage in automotive electronics? In 2004, electronics was 10% of the value of cars; in 2014, it was 35%, and expected to double to 70% in another 10 years.

I understand there is a serious automobile OEM (original equipment manufacturer) that has already partnered with a local established conglomerate on the feasibility of the Philippines as an ASEAN manufacturing hub. This same conglomerate has expanded its electronics manufacturing business by expanding its global footprint in China, Europe and the Americas. It has gone where the business opportunities has told them to go. A major global automobile OEM coming to the Philippines will surely attract its suppliers if it makes business sense to do so, and if there is an attractive investment framework.

These ingredients can be our bridge to a manufacturing future -- a modern industrial service economy that Dr. Felipe spoke of. I hope these investments are made here in the Philippines. A pity if it is lost to a more forward-looking and flexible ASEAN neighbour.

Romeo Bernardo is Philippine GlobalSource Partners advisor and is a Board Director of the Institute for Development and Econometric Analysis (IDEA).

ON THE PHILIPPINES JOINING THE AIIB WHAT’S THERE TO ‘WAIT AND SEE’?

The Aquino Administration appears waffling on the Philippines being an original member of the China-led Asian Infrastructure Investment Bank (AIIB). Last October, it signed a non-binding memorandum of understanding, together with 22 other countries, to become a founding member. Last week, this newspaper reported that the President said “The Philippines needs to be ‘very very cautious’ about becoming a member... with the government obliged to consider Beijing’s behavior in the Scarborough Shoal crisis of 2012, during which the China Eximbank called in a loan that was to fund a rail line to Clark International Airport.”

China’s Asian Infrastructure Investment Bank (AIIB) secretary-general of the Multilateral Interim Secretariat, Jin Liqun (center), leaving during a break in the Fifth Chief Negotiators’ meeting that discussed draft agreements for the China-backed AIIB, in Singapore last month. 
-- Reuters. 

This indecision is understandable. There are pros and cons that need careful weighing, with intertwined and complex political and economic factors in play.

Many in the business community applauded the government, led by the Department of Finance, when it signed up for the AIIB. This is faithful to the spirit of the Aquino-Hu Jintao 2011 meeting that “The territorial dispute shouldn't be the be-all and end-all of Philippine China relations.” Though this idea seemed to have been eclipsed by subsequent harsh exchanges, the fundamental soundness of it remains. My column last year, “Frozen” (April 2014; it can be accessed on my blogspot, http://romeobernardo.blogspot.com/2014/04/frozen.html), underscored economic ties as an important layer to our multilayered relationship with China. Our joining AIIB will be in keeping with that approach.

In the same spirit, my friend Raphael “Popo” Lotilla, University of the Philippines law professor and former energy secretary, provided precious lessons from Vietnam’s richly textured multi-dimensional ties with China over the years, centuries even (“Dealing with Dragons: Lessons from Across the Sea,” Forbes Magazine, May 2015). His article is a most insightful and fact-based telling of how Vietnam fought Chinese troops over centuries on land and at sea while at the same time engaging China, amicably and profitably, in a variety of ways, including in trade, investments and finance.

And yes, Vietnam is set to become a founding member of the AIIB. For that matter, as Popo observed, so with Taipei, “maintaining its application for membership even after its rejection as a founding member.” And as far as territorial disputes go, this one is the mother of them all!

But wait, does Asia really need another development bank? The case for it is made by an Asian Development Bank (ADB) report that says Asia requires $8 trillion in infrastructure from 2010 to 2020. This is a huge number that dwarfs the capital of the ADB ($160 billion), the World Bank ($220 billion), and other official funders. Having one more funder will surely help.

Besides, some competition is healthy. This early, so as not to be outdone, Japan has announced a $110-billion infrastructure financing package for Asia. Moreover, it has not been lost on many how some of the policies and programs of the World Bank, and to a lesser extent the ADB, have at times seem dictated by narrow interest groups in the West, oblivious to infrastructure requirements of developing countries. 

How else to interpret policies in the World Bank and International Finance Corporation that shun the financing of coal power plants even where such plants may be the only ones that makes economic sense for countries for dependable affordable power? Or take the case of a proposed $1-billion financing for highly subsidized solar plants being processed at ADB, until public scrutiny and more serious thinking within the organization shot it down. (See my column, “Renewable Energy, a Reality Check,” January 2011, blog link: http://romeobernardo.blogspot.com/2011/01/renewable-energy-reality-check.html)

In the case of the Philippines, the government’s Comprehensive and Integrated Infrastructure Program calls for $150 billion of financing in the next five years. Only 25% of this is expected to come from private sources, and the balance from development financing either on-budget or official development assistance. Assuredly, our having access to another source of concessional finance over the medium term will help.

Of course, our current constraint in infrastructure spending is not financing but execution. As a glaring example, had government spent available money as programmed, our GDP growth rate for the first quarter of this year would have exceeded the targeted 7% and not be the mediocre 5%.

And on the private side, what may well lead to underinvestment in infrastructure is the idiosyncratic nature of our regulatory regimes, exemplified in the reinterpretation of contracts by the Metropolitan Waterworks and Sewerage System for the water concessions to exclude recovery of the corporate income taxes -- after 17 years of operation.

But surely, our current situation is not one which we should take as a given if we are to achieve over the medium term the poverty reduction and greater participation in prosperity that relieving infrastructure constraints can bring.

There is less reason to waver now that more countries are joining, including developed country allies of the United States (the country most critical of AIIB). These include the United Kingdom, Germany, France, South Korea, and Australia. As of April 15, the AIIB has 57 prospective founding members, including 16 of the world’s 20 biggest economies and our fellow ASEAN countries. As a result, it is also clear now that China will not have veto power.

Officially, the reason given for the Philippines’ sudden “wait and see” attitude is concern over governance, noting lack of transparency in Chinese bilateral aid. This will be given further clarity later this June when the Bank’s charter will be finalized and up for signature. In the meantime, I would argue that the AIIB in fact helps address this concern, given the multilateral framework that enables sharing of knowledge and experience (especially from the WB and the ADB), and subjects projects and funding processes to greater scrutiny of other members.

Moreover, the reality is that China, with its $4 trillion in reserves, will continue to have bilateral facilities for projects meant to win friends, both countries and persons. And flawed projects (such as the still-born ZTE and North Rail) being pushed by one sponsor or another, from China or elsewhere, will not go away. We just need to be more vigilant, especially in watching our own public officials.

And finally, the nomination of Jin Liqun as AIIB president is reassuring. He is a no-nonsense finance executive honed in the Chinese civil service and multilateral development institutions. Early on, he was a representative of China in the World Bank (we were both there in the 1980s), later pursuing a career as an official there, and later the Asian Development Bank, where he recently retired as vice-president for operations, one rung below the president.

Romeo Bernardo is Philippine GlobalSource advisor and is a board director of IDEA.

There’s room to grow some more, if...

BUSINESS WORLD

Posted on March 08, 2015 10:47:00 PM

 I had the privilege of being in the panel of reactors -- together with Former Socio-Economic Planning Secretary Cielito Habito and World Bank senior country economist Karl Chua -- to the lecture of Socio-Economic Planning Secretary Arsenio Balisacan, formerly professor and dean of the highly respected University of the Philippines School of Economics.

This was part of the lecture series sponsored by the Ayala Corporation in support of the outstanding policy research at the School. In the words of Jaime Augusto Zobel de Ayala, “the rigor of the thinking and the clarity of the logic” mark the economic policy studies from the School. This partnership then aims to provide a vehicle to communicate the economic policy studies of the School to the general public.

Earlier lecture speakers in this second series were Dr. Raul Fabella (“Comprehensive Agrarian Reform Program: Time to Let Go”), Dr. Philip Medalla/Dr. Johanna Dee Chua (“Philippines -- Will Financial Stability be at Risk?”), Dr. Ramon Clarete (“Going Regional: Which Mega Trade Deals Should the Philippines Join?”) and Dr. Stella Quimbo (“Should We Re-Think Income Taxation in the Philippines?”). You can access their papers at http://www.econ.upd.edu.ph/ayala-upse/?page_id=71.

The lecture by Secretary Balisacan was on the state of the Philippine economy. Below were my two cents as a reactor:

WE LEARNED of last year’s Gross Domestic Product (GDP) outcome recently. I was most happy that the fourth quarter jumped to boost the growth rate for the year to 6.1%. As some of you may know, Ciel and I have a very well-publicized bet. Our (GlobalSource) forecast early last year on record was actually exactly 6.1%. (We were also pretty much on the mark in 2013, when we forecast 7%, early in the year.)

I am often asked, how sophisticated is our econometric forecasting model given our excellent batting average? My answer: We actually have a crude one -- a single equation, but with amazing predictive power. The equation goes...the National Economic and Development Authority (NEDA) estimate times 0.9%.

Seriously, my bet with Ciel this time around was one I would have much wanted to lose (i.e. had we grown at 7%). Indeed, I do agree with him, as I do now with Secretary Arsi Balisacan and Dr. Karl Chua, that the Philippine economy has the fundamental underpinnings to go beyond its historical 4% over the past two decades, to a much higher level. We at Global Source believe 6% is now our baseline growth rate. It can be higher or lower depending on whether investments will take place, both government (for infrastructure) and the private sector (especially for manufacturing, agriculture/agribusiness).

Allow me to show some figures on how poorly we do in the investment department. Incidentally, it is also investment in these sectors that can employ the non-college educated entrants to the labor force that will spell the difference for future growth to be more inclusive, and for the unemployment/underemployment rate and poverty rates to decline from the unacceptable 25% currently.

Graph 1: Our investments-to-GDP ratio is still lower than our neighbours’ by far. There’s a bit of an uptick recently in the numbers, but we still need to catch up.

Graph 2: Savings vs. Investment -- this makes me cry. We have the domestic resources to put in investments, but instead are going out of the country. The mirror image of the positive current account over a decade that Sec. Arsi showed is high surplus savings for an economy that is starved of public and private investments. The obstacles to such have been well studied.

Graph 3: Likewise, on net Foreign Direct Investment (FDI) inflows, there’s a slight uptick but a lot of catching up to do vis-à-vis our ASEAN neighbours.



These should be seen not as constraints, but as opportunities.

What are the areas where reform can focus on for maximum oomph for the buck?

• Infrastructure. This creates immediate growth impact, and relieves constraints for long-term growth. There are now binding constraints on power, airport, cargo, road network and mass transport. Can we grow at 7% without courting power outage and giant gridlocks in roads, airports, piers?

• Agriculture. I don’t think Sec. Arsi will disagree too much if I said that the depressingly low productivity of this sector and lack of investments are on account of government failure over decades. We will need to see action on two areas: (1) Clarity in land ownership post-CARP (Comprehensive Agrarian Reform Program); and (2) reform in rice support policy/the National Food Authority.

Reforms here will help achieve a number of things -- bring down the cost of food which impacts directly poverty and wage competitiveness, release huge amounts of wasted fiscal resources, and attract investments from the private sector into agriculture and agribusiness.

• Manufacturing. Focus on reviving the manufacturing sector by adopting policies that favour job creation. There are a number of initiatives that have been started, and hopefully can be brought to fruition: Rationalization of fiscal incentives so that these are directed to areas with highest linkage/benefits and are performance-based, industry road maps that better coordinate efforts of government units and the private sector, and cutting red tape for setting up of businesses.

Additionally, labor laws and regulations can be made more investment friendly -- the World Bank shows we have high minimum wages vs. peers. It is in this segment where we need to create employment that benefits most the poor and unskilled.

Indeed, there is still much room to grow, maybe 7-8%, if we are able to build on the current growth drivers of remittances and business process outsourcing (BPO), and a young population and structural current account surpluses, with another leg: investments.

There are, moreover, upsides outside our shores in the horizon. Oil prices have halved to what they were, and from all indications will stay low, driven as it is more by supply forces rather than demand (vs. what happened in 2009). The raw numbers are that for every $10 drop in oil price, we save around a billion. This goes directly to the current account, adding another $5-6 billion. Oxford economics estimated as much as 1.8 percentage points GDP gain for the Philippines. This will translate into higher consumption growth numbers as the lower prices cascade to a lower consumer price index. This also means interest rates can stay low longer, with all the beneficial effects that this has on the economy. The global economy likewise benefits from this -- including important Philippine export markets.

Another upside is opportunities created by the ASEAN Economic Community (AEC), which makes the region a single market. The Philippines is seen as competitive in the services sector. Even in manufacturing, I am aware of local groups well positioned to manufacture for a multi-ASEAN country market; they just need a supportive government environment.

The AEC may also be the impetus that will drive reforms for further opening, competition and efficiency in the domestic market. We have seen that, with the Bangko Sentral recently successfully pushing for the liberalization of investments in the banking sector.

There are also downside risks. The drop in oil prices may contribute to the acceleration of Saudization policy (increasing the required Saudi nationals as percent of workforce). A quarter of our overseas workers are in Saudi Arabia. Heightened uncertainty in the regulatory and local government regimes for key infrastructures -- power, water, road and cargo handling -- is another source of downsides for public-private partnerships and long term growth.

Sec. Arsi mentioned also natural disasters as historically imposing downside surprises. Allow me to mention the man-made kind.

The boom-bust of the recent past mentioned by Sec. Arsi in part mirrors political turbulence and compromised leadership. This can happen again in 2016 if the elected leader is not credible, or if elections are not credible. We sadly saw examples of each case in 1998 and 2004. Let us do our best to make sure neither happens again.

Romeo Bernardo is Philippine GlobalSource advisor and is a Board Director of the Institute for Development and Econometric Analysis.

romeo.lopez.bernardo@gmail.com

...and of a metro train subsify

Business World

THE GOVERNMENT should cut and minimize its subsidy to the metropolitan rail system, and allow market forces to dictate the cost of riding the MRT and LRT.

This is most likely an unpopular position, particularly since the metropolitan rail system offers a viable alternative to the public’s everyday commuting concerns. Let us explain our position on the matter.

First, the persistent and festering problems plaguing the MRT and LRT service cannot be reasonably solved if we continue the existing rate and level of government subsidy.

It has been politically expedient across successive administrations to subsidize the fares of Metro Manila train commuters. But the demonstrable mismanagement of this relatively small train system only corroborates the unsoundness of a policy that keeps fares below their economic value and marginal cost.

Train fares have stayed the same since 2003, even with the general price level nearly doubling since the beginning of 2000, while fares for other public transport modes (buses and jeepneys) have been adjusted periodically. However, train travel offers shorter and more predictable travel times, and thus should cost more. A sound fare policy will take into account the relative economic values (and competitive advantages) of every transport mode. Fare setting for the MRT-LRT and Philippine National Railways systems should not be done in isolation from the prevailing fares on non-train transport.

As a matter of equity and efficiency, fares should be set to the maximum extent possible, based on recovery of costs (operations and maintenance, or O&M) and the “users pay” principle. Government subsidy becomes justifiable only when full-cost recovery fares exceed the economic value of train travel, which by definition incorporates what the average commuter is willing and able to pay. New York City Transit prides itself on having the best recovery ratios in the United States, but manages to cover only 53% of its costs from rider fares.

When subsidies are misplaced, demand is distorted and unintended consequences abound. For example, a 2010 study showed that riders from the economically disadvantaged sector (with a monthly income of P8,000 or less) accounted for only one-third of Metro Manila train riders. The subsidy ends up benefiting, not the poor, but mainly non-poor riders who understandably flock to the cheapest transport alternative. This overflow of non-poor riders aggravates the strain on train system operations and maintenance, compounding the damage already caused by negligent management.

The 2015 budget already allocates P7.4 billion for MRT rehabilitation, while a supplemental 2014 budget contains nearly P1.2 billion for the rehabilitation of both MRT and LRT. Arguably, these funds, properly spent, might already suffice.

However, audits by international experts have confirmed that years of maintenance neglect have led to the deterioration of service quality and safety to dangerous levels.

The only other meaningful action proposed by certain transportation officials -- a government buyout of private equity interests in the MRT -- was a purely financial deal that only benefited the banks and none of the other stakeholders, most especially the riding public.

In an election year, given our patronage politics, the public has every right to worry that funds raised from the fare hikes might be diverted for partisan purposes. Such worries can only be aggravated by the lack of public consultation, transparency, and third-party oversight that surrounded the fare increase process.

In the end, misplaced subsidies do the biggest damage to those among us who have the lowest tolerance for wasted resources -- namely, the poor and economically disadvantaged. Thus, the Foundation supports not just the current fare hike, but also a series of successive fare hikes that will gradually phase out all misplaced government subsidies to Metro Manila’s train system and contribute to full rationalization of relative pricing among the various transport alternatives. The P2.3 billion of subsidy savings expected from this first fare hike is a good start, but it is only a start.

Second, we need measures that will address this subsidy concern.

Policy reforms must be instituted so that future fare setting is insulated from political grandstanding, system management is professionalized, and the present train network can expand from its current size of 79 kilometers to more than 200 kilometers by the year 2030.

Consider setting up a multisectoral oversight body -- to include civil society, the business sector, and international experts -- as a confidence builder for the public and an additional resource for the evidently inadequate Department of Transportation and Communications.

Immediately replace the current maintenance contractor with a globally reputable provider equivalent in quality to Sumitomo, the previous contractor.

Agree upon clear rehabilitation and maintenance milestones, with corresponding rewards and sanctions for over- and under-performance. People’s heads must be put on the line. Clearly specify where the additional funds generated from freed-up subsidy monies are to be used within the overall transportation sector.

Innovate additional revenue sources and cost savings in order to minimize fare hike requirements. On the revenue side, real estate and signage deals come to mind. On the cost side, automation and integration of all fare collection processes must be expedited as one of the performance milestones.

Good ideas, like train fare hikes, must not be dragged down by bad managers, bureaucrats and politicians. Sound economic policy must not be held hostage by unsound governance.

The issue of increases in the MRT and LRT fares continues to occupy media space, the streets, and the courts. I yield this space to a recent statement on this by the Foundation for Economic Freedom, an advocacy group for market-friendly reforms and good governance. While the statement is focused on tariff adjustments for MRT-LRT to achieve utmost equity and efficiency, the thinking applies with equal force to other infrastructure with both private and public benefits -- toll roads, water, power, trains, ports, airports, etc. Infrastructure inadequacy has been tagged as a top binding constraint to the country’s sustainable and inclusive growth.

An unspoken message in the statement is that the private sector will be discouraged from investing in such much-needed public-private partnership infrastructure if tariff setting impedes proper maintenance and cost recovery, and is politicized. And at the end of the day, what is the most expensive water, power or road network? Not having any:

Romeo Bernardo is Philippine GlobalSource advisor and is a board director of IDEA.

Talkies for presentation during AC UPSE forum, 29 Jan 2013

Thank you for the invitation. An honor to share podium with Sec Balisacan, as well as Dr. Habito and WB Senior Economist Karl Chua.

I apologize for any repetitions. I have always been a follower of Prof. Arsi, and a religious reader of Ciel's column and Karl's researches-- so I guess such agreement unavoidable (I can't help wonder if we would not have had a lively and fun afternoon  if Prof Ben Diokno or  Prof Mareng Winnie were here instead of me).

We learned of the last year’s GDP outcome this morning. I was most happy that the fourth quarter jumped to boost the growth rate for the year to 6.1 percent. As some of you may know, Ciel and I have a very well publicised bet.  Our forecast early last year on record was actually exactly 6.1 percent. (We were also pretty much on the mark in 2013, when we forecasted 7 pc, early in the year.)
I am often asked, how sophisticated is our econometric forecasting model given our excellent batting average?  I answer-- we actually have a crude one—a single equation, but  with amazing predictive power. The equation goes—

NEDA estimate times 0.9 percent.
Seriously, my bet with Ciel this time around was one I would have much wanted to lose (i.e. had we grown at 7 percent).  Indeed, I do agree with him, as I do now with Sec Arsi Balisacan Dr Karl Chua that the Philippine economy has the fundamental underpinnings to go beyond its historical  4 percent over the past two decades, to a much higher level.  We at Global Source believe 6 percent is now our baseline growth rate. It can be higher or lower depending on whether investments will take place, both government for infrastructure and the private sector, especially for manufacturing, agriculture/agribusiness.

Allow me to show some slides on how poorly we do in the investment department. Incidentally, it is also investment in these sectors that can employ the non-college educated entrants to the labor force that will spell the difference for future growth to be more inclusive, and for unemployment/underemployment rate, and poverty rates to decline from the unacceptable 25 percent presently.

Refer please to the following slides:
1.     Investments to GDP—lower than our neighbour’s, by far. A bit of uptick, but still...

2.     Savings vs. Investment—this slide makes me cry. We have the domestic resources to put in investments, but instead going out of the country. The mirror image of the positive current account over a decade that Sec Arsi showed is high surplus savings for an economy that is starved of public and private investments. The obstacles to such have been well studied.
(S-I = X-M)

3.     FDI- likewise, going elsewhere ASEAN by far—slight uptick but...
These should be seen not as constraints, but as opportunities. 
What are the areas where reform can focus on for max oomph for the buck?
1.         Infrastructure—creates immediate growth impact, and relieves constraints for long-term growth. These constraints binding now—power, airport, cargo, road network and mass transport.  Can we grow at 7 percent without courting power outages and giant gridlocks in roads, airports, piers?
2.         Agriculture policies.  I don’t think Sec Arsi will disagree too much if I said that the depressingly low productivity of this sector and lack of investments are on account of government failure over decades.  We will need to see action on two areas

a)      Clarity in land ownership post CARP, and

b)      Reform in rice support policy/NFA.

Reforms here will help achieve a number of things—bring down cost of food which impact directly poverty and wage competitiveness, release huge amounts of wasted fiscal resources, attract investments from the private sector into agriculture and agribusiness.

3)         Focus on reviving manufacturing sector by adopting policies that favour job creation. There are a number of initiatives that have been started, and hope can be brought to fruition. Rationalization of fiscal incentives so that these are directed to areas with highest linkage/benefits and are performance based,  industry road maps that  better coordinate efforts of government units and the private sector, cutting red tape for setting up business.

Additionally, labor laws and regulations can be made more investment friendly—the World Bank shows we have high minimum wages vs. peers.  It is in this segment where we need to create employment that benefits most the poor and unskilled.

The earlier slides showed how much room there is to grow, maybe 7-8%, if we are able to build on the current growth drivers of remittances and BPO, and a young population, structural current account surpluses, with another leg—Investments.

There are moreover, upsides outside our shores in the horizon.  Oil prices have halved to what they were, and from all indications will stay low driven as it is more by supply forces, rather than demand (vs. what happened in 2009). The raw numbers are that for every $ 10 drop in oil price, we save around a billion.  This goes directly to the current account, adding another $ 5 to $ 6 billion. Oxford economics estimated as much as 1.8 percentage points GDP gain for the Philippines.  This will translate into higher consumption growth numbers as the lower prices cascade to lower CPI.  This also means interest rates can stay low longer, with all the beneficial effects that has on the economy. The global economy likewise benefits from this—including important Phl export markets.

Another upside is opportunities created by ASEAN Economic Community, which makes the region a single market. The Philippines is seen as competitive in the services.  Even in manufacturing, I am aware of local groups well positioned to manufacture for a multi-ASEAN country market; needs a supportive government environment. 

AEC may also be the impetus that that will drive reforms for further opening, competition and efficiency in the domestic market.  We have seen that with the BSP recently successfully pushing for liberalization of investments in the banking sector.

There are also downside risks. The drop in oil prices may contribute to the acceleration of Saudization policy (increasing the required Saudi nationals as per cent of work force).  A quarter of our OFW's are in Saudi Arabia. 

Sec Arsi mentioned also natural disasters, as historically imposing downside surprises.  Allow me to mention the man made kind.

The boom bust of the recent past mentioned by Sec Arsi in part mirrors political turbulence and compromised leadership.  This can happen again in 2016 if the elected leader is not credible, or if elections are not credible. We sadly saw examples of each case in 1998 and 2004. Let us do our best to make sure neither happens again.

The art and science of monetary policy

Posted on January 04, 2015 08:59:00 PM

BUSINESS WORLD

AMANDO M. TETANGCO took over the helm of the Bangko Sentral ng Pilipinas (BSP) in 2005 and was soon thrust into a different world that someone without his 30-year central banking experience, including during the turbulent debt crisis years in the early 1980s and the Asian financial crisis in the late 1990s, would have been ill-prepared for.

This time, he had to deal with the aftershocks of the 2007 global financial crisis where emerging markets like the Philippines were left to fend for themselves as central banks in developed economies pursued unprecedented quantitative easing, and their attempts at forward guidance produced instantaneous market reactions that rippled through financial markets everywhere.

The BSP under Governor Tetangco’s watch oversaw a long period of monetary and financial stability that made recent fiscal consolidation efforts and investment grade ratings for the sovereign credit possible. To date, the country continues to enjoy a combination of steadily higher economic growth and low inflation, high foreign exchange reserves, a well-capitalized banking system, and praises for inroads made in microfinance and financial inclusion.

Governor Tetangco is the only BSP governor to serve two terms, having been reappointed in 2011 by President Benigno Aquino for a second six-year term -- quite a feat considering how the current administration has campaigned aggressively against the previous one. The re-appointment was read by analysts and markets not only as a tribute to his personal qualities but as the coming of age of the Central Bank as a mature independent professional institution.

As the Philippines enters the 2016 presidential elections, market watchers take comfort that Governor Tetangco’s term ends in 2017. These are excerpts from an interview by Christine Tang and GlobalSource, a New York-based network of independent economic and political analysts.

Q&A: Bangko Sentral Governor Amando M. Tetangco

Markets are again bracing themselves for increased volatility. What is your baseline scenario on external economies and markets?

The global economy will continue to grow in 2015, but uncertainties remain. The US economic recovery is seen to gain traction, while the recovery in advanced economies could likely continue to be hindered by financial imbalances, and growth in some emerging market economies (EMEs) may face structural bottlenecks. We expect a continuation of divergent monetary policies between the US on one side and EU and Japan on the other; and we see global investors continuing to take their cues for capital flows from this divergence.

Are you more concerned today about Asian risks -- a Japan recession and a China slowdown -- in terms of their impact on exports than, say, six months ago?

There are certainly developments in China and Japan that bear watching. In China, growth is seen to be slowing “faster than consensus.” Some analysts describe this as a “bumpy landing.” However, the recent surprise monetary policy actions as well as market expectation of “meaningful financial sector reform” from the administration should help to rein in market confidence. These measures are expected to buoy the Chinese economy. As for Japan, its economy has entered a technical recession. And it seems like structural reforms, including new tax measures, will continue to face challenges.

Slower Asian growth could adversely affect the Philippines. However, if the US economic growth does gain traction, this could be positive for the Philippines and serve to even out the trade prospects for us.

How worried are you about contagion risk, given markets’ knee-jerk selling of anything that carries an “emerging markets” tag?

The way we see it for the Philippines, markets will eventually get their bearings back, filter out the “noise” and realize that strong domestic demand will continue to hold up.

Our policy therefore remains geared toward a careful calibration of policy interest rates, the containment of excessive volatilities in the exchange rate, selectively employing macroprudential measures when appropriate. We are also careful to communicate our policy objectives so that we eliminate (to the extent possible) market surprises, so that business planning can be more strategic and long-term.

On the domestic side, what is your baseline view and what are the major downside risks?

Our baseline view is for the economy to grow in a “within-target” inflation environment. The major risks to this view include external factors that could lead to financial market volatility that could, in turn, result in repricing risks to household and corporate debt. Other major risks are fiscal underspending, power shortage, and natural disasters.

What is your outlook on domestic economic growth, inflation and interest rates, and the exchange rate under your baseline scenario?

We see the risks to future inflation as more broadly balanced. Upside risks to inflation include pending petitions for utility rate adjustments and possible power shortage, while downside risks include slower-than-expected global economic activity. Given a manageable inflation outlook, we have room to keep rates low to support economic growth. In addition, the ample liquidity and the national government’s good cash position should keep the yield curve steady.

On the exchange rate, we don’t target a specific level, but we will maintain a presence in the market so that volatilities are kept low. We also will keep a close eye on market conduct. We are watchful of the developing “strong US dollar” scenario.

Which one poses the bigger downside risk in your 2015 outlook: fiscal underspending or disinflation?

I would say fiscal underspending rather than disinflation. I say this because confidence and aggregate demand remain buoyant to ward off disinflation. Private consumption and construction continue to contribute positively to growth.

That said, the national government has not stepped back from its target on infrastructure spending; and we do badly need infrastructure. We’re going to see spending for the improvements in relation to Asia-Pacific Economic Cooperation meetings, plus reconstruction following natural calamities, in addition to the projects that are already in the pipeline.

There is this sentiment among some analysts that monetary policy seems easy and yet inflation is held down by soft commodity prices resulting in a situation of strong growth and negative real rates. Do you agree that current policy settings are loose?

I think policy settings are currently just right. Neither too loose nor too tight. As I said, the risks to the inflation outlook are broadly balanced.

What are the factors or events in the 2015 macro horizon that will likely lead to an interest rate hike? What is your assessment of the risk of actual inflation overshooting your lower inflation target next year?

On the upside, it would be higher prices of food commodities -- due to natural calamities here and abroad, and supply chain disruptions -- that could cause inflation to overshoot the upper end. Food accounts for more than 40% of the basket. But neither this nor sustained lower international prices of oil -- which would be a very strong factor for inflation to fall below the lower end of the target next year since fuel and related items account for about 9% of the basket -- are within BSP control. Hence, we are heightening our surveillance and analytics in order for us to be able to make appropriate adjustments in a timely manner.

What is your assessment of the continuing growth in domestic credits and rising asset prices?

Our assessment remains to be that there are no general or pervasive stretched asset valuations, especially in real estate.

What are your thoughts on the view that stricter financial sector regulations may drive activities outside where excesses may build up unmonitored?

We are rather mindful of the possible perverse result whereby specific macroprudential measures and banking regulations in general encourage yield-seeking in the shadow or unregulated markets. This phenomenon has at times been referred to as the “balloon effect,” -- you squeeze one part and the other parts bulge. So far, however, the macroprudential measures we have in place have been effective in signaling policy intent, and in eliciting the anticipated market behavior.

As they say, monetary policy is an art as much as a science. It requires a healthy balance of analytics and creativity and boldness. Without getting bogged down with analysis, you craft scenarios creatively, calculate the risks of these possible actions, and make the best decision given the information you have. And equally importantly, communicate your decision well.

What is your tolerance for further peso depreciation? Would another 5% depreciation from current levels over a one-year horizon be acceptable?

Under the inflation targeting (IT) framework, there is greater tolerance for exchange rate movements. The exchange rate passthrough has gone down after the adoption of IT compared to the pre-IT period. Even so, we remain mindful of exchange rate movements because these could have balance sheet effects that can have an impact on overall inflation expectations.

We don’t target a specific level, nor do we target a full-year depreciation or appreciation rate. Given what we know of the exchange rate, that it affects different sectors differently, we essentially leave the rate level or trend to the market. What we more closely watch is the speed of the changes, within the period. In other words, volatility, especially when these threaten a potential breach of the inflation target.

Which would you say is the lesser evil for the BSP at this time: excess capital inflows or capital outflows?

At this time? The “lesser evil” would be capital inflows. I think the door for excessive inflows is narrower than it is for outflows, given the uncertainty with Fed normalization. In other words, we are more likely to see capital outflows than inflows.

The BSP is, however, geared for both scenarios. Among other instruments available in our enhanced tool kit, we have macroprudential measures in place for inflows, and we have the flexibility to maintain a strategic presence in the foreign exchange markets to address outflows.

But as we know, monetary policy cannot carry the full burden of adjustment. More fundamentally, we need to amp the absorptive capacity of the economy so that capital inflows would be “captured” and converted into permanent capital for real assets, as opposed to financial assets, that have stronger economic multiplier effects.

This involves, among others, increasing investments in infrastructure and strengthening the country’s institutions. In this way, the risk of capital outflows is minimized. The goal really is to steer inflows toward what the IMF calls “economic risk taking” rather than “financial risk taking.”

Other than the 2016 elections that can change the political/economic agenda, what structural issues would deter investment-driven growth in 2016 and beyond? How would monetary policy respond to such structural issues?

Legal, contract issues. Bidding procedures. Speed of execution. Taxation. All issues that could lead to improvements in the climate/cost of doing business in the country. On the BSP side, we will, as we always do, respond with policies that will create stability, both price and financial, so that market participants can anchor plans on these.

Going to the banking sector, could you share with us the results of your latest stress test of domestic banks? What are the macroeconomic shocks that the system is most sensitive to?

Universal and commercial banks are in a position to withstand extreme but plausible shocks in both credit and market risk. Uncertainty in the speed and extent of normalization of monetary policy in advanced economies remain the key source of risk for the banking system.

The expected rise in global interest rates, coupled with continued credit expansion to the property and consumer sector, render the banking system vulnerable to borrower default. Mindful of this, the BSP has implemented regulatory reforms to strengthen capital buffers and risk management practices.

Other risks?

Risks arising from corporate and household leverage and conglomerated lending are also closely being monitored in collaboration with counterpart regulators from a financial stability perspective.

Regarding current moves toward ASEAN financial integration, what realistically can we expect to see in the next two years?

ASEAN financial integration, particularly the entry of foreign players into our domestic market, should increase competition, help us reap the benefits of transfer of technology in terms of improvements in processes and raising human capacity, as well as broaden markets.

I foresee that there will be good synergy between the existing local banks and the new entrants. Local banks will remain dominant, especially in the growing retail banking space, while foreign banks will find their strength in providing regional and global connectivity through correspondent banking services and access to the international capital markets. Foreign banks will also be able to facilitate the banking needs of the local branches of companies from their home countries. Our local banks should use this opportunity to raise the level of their game, if they are to compete successfully with the bigger banks in the region.

Halfway through your second term, do you have other to-dos are in your worklife bucket list?

Yes, certainly. First, to deepen financial inclusion further to create a more palpable inroad into making economic growth truly inclusive and broad-based. Second, true capital market reform. Even as we speak, the capital market blueprint is being rewritten by global market reform. Third, an even stronger BSP institution.

How do you want people to remember your governorship?

When I took this job on in 2005, I said there was no need to reinvent the wheel. I was going to continue with the reform agenda of my predecessors, which after all I helped craft as an insider, and bring those to fruition.

However, the world we operate in changed dramatically in 2007. The traditional paradigms were shattered, and policy became of the “nonconventional” type. I would like to think that under my stewardship, the BSP has proven itself alert, nimble, responsive, and able to provide the stability necessary to give direction that the market needs at any time.

Part of this column was culled from a recent GlobalSource report written by Christine Tang and Romeo Bernardo. Mr. Bernardo is Philippine GlobalSource advisor and is a board director of IDEA.

romeo.lopez.bernardo@gmail.com

Fourth-quarter GDP rebound: It’s still possible

Introspective
Business World

THERE ARE BETS you’d rather lose. My good friend former socioeconomic planning secretary Ciel Habito and I have a running bet on the GDP growth for this year. His is optimistic at 7% and mine is conservative at just above 6% forecast. With the release of the third-quarter GDP growth at 5.3% last Thursday, it looks like I have a “free” lunch, care of Ciel.

We may disagree on our numbers, but Ciel and I both see that the key to higher growth lies in the government getting its act together. The government has much to do in terms of relieving infrastructure constraints to drive economic growth both in the short and long term. Short-term growth would be propelled by government spending for infrastructure and by construction of public-private partnership projects, long-term growth by the resulting improvement of connectivity and efficiency in the market attracting private investments that would create jobs and generate economic activity.


However, last quarter’s GDP growth dipped anew, dragged down by low government spending especially for infrastructure and by the poor state of road transport and seaports. It seems that the government is not doing enough to straighten out its troubles.

Back in July this year, we at GlobalSource wrote that “the setback caused by the Supreme Court decision on public spending as well as the slowness in decongesting the Port of Manila threatens 3Q14 economic growth” and proceeded to pare our 2014 GDP growth forecast to 5.8%. When August data showed better-than-expected second-quarter growth, we said that “the economy is not yet out of the woods in terms of bearing the costs of port congestion, which will feed into prices and economic activity in 2H14” but conceded a return to our start of the year 6.1% forecast.

And indeed third-quarter growth, reported at 5.3%, is way below the 6%-6.5% figures from journalists’ polls. Apart from government underspending (consumption and construction fell 2.5% and 6.2% respectively) and the seven-month-long gridlock at the main international seaport in Manila (despite its growth-boosting impact via weak imports, it may have also caused lower inventory buildup and on the supply side, an evident slowdown in transport and storage services), a mix of higher inflation and lower peso remittance growth saw household spending slowing down (to 5.2% in the third quarter from a revised 5.7% in the second quarter and 5.9% in the first quarter). At the same time, bad weather led to a 2.7% decline in agriculture, which is about 10% of GDP.

The much lower third quarter performance brought year-to-date GDP growth to 5.8%. With fourth quarter economic activity typically supported by Christmas festivities and upbeat consumer and business sentiments, what is the likelihood of fourth-quarter GDP reaching the 6.8% needed to achieve our latest 2014 forecast?

There is good news. Inflation is decelerating, port cargo movement has reportedly improved with the lifting of the local government’s truck ban, private construction shows momentum (12.7% in the second quarter and 15.7% in the third quarter), and despite the reported recession in Japan and slowdown in China, exports to these two major trade partners show robust growth (20% and 22% in nominal dollars, respectively, from January to September).

On the other hand, we continue to wrestle with the question of whether or not government can deliver on its promised spending. During the pre-DAP (Disbursement Acceleration Program), high growth periods, public sector consumption and construction together contributed anywhere from one to almost three percentage points of quarterly GDP growth. Hence, if government officials are rightly optimistic about rehabilitation spending gaining traction, a high fourth-quarter GDP growth is feasible. But how likely is it?

Part of this column was culled from a recent GlobalSource report written by Christine Tang and Romeo Bernardo. Mr. Bernardo is Philippine GlobalSource advisor and is a board director of IDEA.