Tooling our central bank

Business World
Introspective

Seasoned central bankers tend to be alert to the giant sucking sound of capital inflows that make balancing the oftentimes conflicting goals of stable inflation and output growth much harder. This policy challenge stems from the impossible trinity where in a world of mobile capital, the central bank cannot expect to remain in charge of setting interest rates if it wants stable exchange rates, without imposing capital controls.

In most discussions of this policy trilemma analysts usually ignore the impact of sterilization efforts on central bank balance sheets, i.e., of having to carry low-yielding foreign exchange assets and paying high interest on local currency liabilities. This is because central banks are not supposed to worry about how their policies, aimed at keeping confidence in the domestic currency, affect their bottom lines in the short run. In practice though, the prospect of having to explain losses to a hostile congress weighs heavily on and may even skew central bankers' policy choices.

In the case of the Philippines, when the old Central Bank failed and Congress deliberated on the new monetary authority's powers, avoiding a repeat of the massive losses was of paramount concern to lawmakers. Hence, the newly set up Bangko Sentral ng Pilipinas (BSP) was barred from pursing developmental activities and constrained from financing government deficits. Regrettably, in its zeal to avoid any loss-making functions and failing to appreciate the context to which it was used, Congress also zoomed in on central bank bills. More popularly known as Jobo bills after then Central Bank governor Jose B. Fernandez, these were issued at interest rates exceeding 40% at the height of the mid-80s crisis to restore confidence as inflation spiraled (reaching 60% at one point) and the peso plunged. And so, arguing Let the Jobo bills and all these borrowings not happen again because they caused the downfall of the present Central Bank, Congress limited its use only in cases o f extraordinary movement in the price level.

Unfortunately, this legal handicap deprived the BSP of a vital tool for mopping up excess money from the system, a problem exacerbated by its limited holdings of Treasury securities that can be used for open market operations. Hence, when money started pouring in and monetary authorities found money supply growth too high for comfort, the BSP resorted to other measures including macroprudential regulation and accepting deposits not only from banks but starting mid-2007 their trust units as well. The opening up of the Special Deposit Account (SDA) to a wider investment base siphoned off hundreds of billions of pesos from the financial system (the BSP's SDA grew more than sevenfold in 2007 from approximately P50 billion at the end of 2006).

In succeeding years, as Filipino workers' earnings grew, business process outsourcing (BPO) revenues boomed and central banks in industrial countries loosened monetary conditions in response to the global financial crisis, more and more funds rushed into an economy ill-prepared to absorb them and amounts in the BSP's SDA climbed rather steeply, reaching almost P1.7 trillion by the end of 2011.

While the BSP has seemingly managed without the power to preemptively issue its own securities, its increasing reliance on SDAs, which are nontradable and fixed-term, to drain liquidity has in fact weakened the transmission of monetary policy through credit channels. This may be seen in the divergence between 90-day Treasury bill rates, to which bank lending rates are benchmarked and policy rates, with the former falling below the latter since late 2010.

Moreover, interest rates on SDAs are at a premium over comparable tradable bills indicating that these cost the BSP more to use and hurt its profit and loss account more. At the same time, by offering higher-than- market returns, SDAs also stifle capital market development as investors can opt to move as much money as they want at the set rate into these risk- free accounts.

To be sure, SDAs have one advantage over tradable securities in a highly speculative financial environment. Since they can be accessed only by banks, their trust entities and corporates they are effective in blocking certain hot money inflows and with current interest rates in the US near zero, are less vulnerable than tradable bills to the carry trade (i.e., borrowing low-interest currencies to invest in high-interest ones). Nevertheless, to the extent that a larger part of inflows into the Philippines are of the structural kind (anchored on remittances, BPO revenues and other service receipts), it makes eminent sense to amend the law and arm the BSP with the power to issue its own paper preemptively. After all, the more tools the BSP has at its disposal (even if it may never have to use some of these), the better prepared it is to manage the complexities of today's financial world and the better able it is to calibrate its interventions to achieve specific objectives.

At the end of the day, the public and its representatives in Congress should fret less about central bank short-term losses and concentrate instead on whether it is performing its basic mandate of ensuring stable prices while at the same time delivering on other growth requisites like keeping peso volatilities to a minimum, allowing continuous capital flows especially those motivated by good macro fundamentals and outlook, and retaining policy independence to help steady the economy and the financial system in the face of global shocks.

But if Congress must keep an eye on how the central bank's financial profitability affect public sector finances, it should focus instead on the BSP long-term financial sustainability, as this is what matters for central bank financial independence and to which central bankers should be held accountable. In this regard, the national government should immediately release the long-delayed P30-billion remaining capital of the BSP and not wait for the nth hour of a crisis to act, when the BSP's credibility is at stake and the amount becomes meaningless. A bolder move would require recognizing that to a degree BSP sterilization serves a political and social purpose, i.e., maintaining a competitive exchange rate, the cost of which should be borne by the national government and explicitly accounted for in its budget. This should bring monetary policy discussions properly back to the core issues of the impossible trinity.

Romeo Bernardo is a board member of The Institute for Development and Econometric Analysis and Philippine Partner of GlobalSource. He was undersecretary of Finance during the Aquino 1 and Ramos administrations.

A tale of two taxes, two presidents

Business World
Introspective

President Aquino's leadership and resolve is at a test as he and his congressional allies are lobbied, bombarded and Noynoyed by divergent interest groups on two very live tax policy issues: a) the rollback of the VAT on oil products, and b) reform of excise taxes on cigarette and tobacco (sin taxes). Having just co-authored a case study on the political economy of the reformed VAT for the ADB, I think there are lessons in the field of tax policy reform that can be learned by the President from his predecessor and former teacher, including what not to do.

THE EXPANDED VAT - IT TOOK PRESIDENTIAL BACKING
The reform of the VAT in 2005 has been credited with reversing the alarming deterioration in fiscal numbers during the first part of the Arroyo administration and made the economy more resilient to the global financial crisis of 2008/2009. It also introduced structural reforms to the VAT system, making it more robust, broader and fairer, while plugging major leakages.

The process of getting the legislation through was not an easy one - it involved not only players in both houses of Congress and civil servants but academic institutions, development partners, business groups and civil society pushing for it, on the realization that this was the essential medicine needed at that time to forestall a fiscal crisis.

Ultimately, what made it happen though was full support of President Arroyo. After initial reluctance, she pulled all stops to get her congress and senate allies behind it. While there was a later knee-jerk attempt to back-track, after the hello Garci episode weakened her politically, the dire consequences of such flip-flopping on our the country's credit rating - and perhaps more viscerally, her own credibility - returned policy making to sobriety.

SPECIAL VAT TREATMENT FOR OIL PRODUCTS?
Fast forward to present: This 2005 VAT reform law with the desirable feature of having a broad base that was passed with great difficulty is under attack by transport groups, mass organizations, media columnists, and a few academics clamoring for special treatment of oil products. The reasons why it would be wrong to cave in were excellently argued in this space by my fellow IDEA director and Introspective columnist, UP Professor Noel de Dios (The right thing is doing nothing, March 18 ).

The crux of it is that there are no good reasons to tinker with the VAT rate for a product like oil. Moreover, similar policy, like the preferential, i.e. lower excise tax on diesel compared to gasoline, has led to wasteful distortions in consumption and production.

The recommendation of former UP professor and Planning secretary, now Monetary board member, Philip Medalla is not to tinker with the VAT system, but for the government to give rebates to jeepney operators/drivers. This is both more effective and more equitable in that it does not give tax cuts to car owners, a privileged minority in our society. Under Energy Secretary Rene Almendras' watch, this is exactly what the administration is doing.

(Lesson 1 for the current administration: Stay the course. Don't undo a good thing.)
As to how to respond to anNoynoyers? I second Prof de Dios's recommendation - Ignoy them!
SIN TAX REFORM, IT'S TIME!
There were serious shortcomings in the law amending tobacco and alcohol excise taxes passed in 1997, as a result of successful lobbying by dominant tobacco and alcohol manufactures. These flaws included - no automatic indexation mechanisms (the tax is eroded by inflation); and heavy discrimination in favor of existing dominant players.
As a consequence, the government's take from sin taxes dropped progressively over a decade, contributing importantly to its deteriorating fiscal position.

This, even as the Philippines with among the cheapest cigarettes and alcohol products tops the list of countries with high incidence of the young taking up smoking and drinking, with its attendant high social costs.

Efforts at remedial legislation to correct these flaws yielded only watered-down versions of the DoF proposals being passed. Though this can be traced again to the enormous lobbying power of the dominant players, at the heart of it, what doomed reform was lukewarm support of President Arroyo for this, a sharp contrast to her vigorous sponsorship of the VAT reform law.

(In truth, sin tax reform where potential adverse impact is concentrated on a few big players who have been experts in the game of influencing legislators has turned out to be more politically difficult than the VAT reform where the tax incidence is broadly shared by the general public.)

Fast forward to today: There is a new sin tax reform bill being deliberated in Congress that has garnered tremendous support from civil society, business groups, including former secretaries and undersecretaries of Finance and Health across administrations. The bill brings compelling benefits - it will raise revenues of about P60 billon, the bulk of which will be for universal health care, a key pillar in the government's inclusive growth agenda.

The P-Noy administration has a critical window before the next election to pass this long-delayed reform legislation and mark a game chance in being able to overcome entrenched interests that have captured Congress in the past.

(Lesson 2 from the VAT experience in 2005 - The President needs to pull all stops to get this bill passed.)
The passage of such a law may well be the acid test for credit rating agencies and investors on government's seriousness and ability to deliver on its governance and economic reform agenda. It addresses concerns over the sustainability of government's long-term fiscal position and financeability of its social and infra spending program.

An upgrade to investment grade level, where all our original ASEAN neighbors are, can unlock a virtuous circle of investments, job creation, and confidence, including for bolder reform, that can finally bring us to a higher growth path. Tuwid at maunlad na daan!

Romeo Bernardo is a board member of The Institute for Development and Econometric Analysis. He was undersecretary of Finance during the Aquino 1 and Ramos administrations.

Dragon, or drag-on?

Business World
Introspective

One would think the year 2012 should be a particularly auspicious one, as it belongs to the dragon, a symbol of might and intelligence and the only creature of myth and legend among the Chinese animal signs. But global recovery is expected to stall in the near term with the euro zone likely falling into a mild recession, and it may be just the mythical nature of the beast that would be relevant to describing economic activity in the New Year and not delivery of good fortune.

From a slow 3.7% in 2011, we expect economic growth to improve moderately to about 4.5%, though an expansion that relies on continued remittance flows and some recovery in exports will unavoidably be fragile because of intensifying risks elsewhere in the world. The steadier engine this year should instead be public spending, as the government seems fully committed to reversing the underspending that had occurred last year when it stepped up its anti-corruption drive.

Looking at purely domestic events, the impeachment proceedings against the Chief Justice offer a temporary distraction to both Houses of Congress, taking lawmakers' attention away from important economic bills. Even if the trial does drag on a bit, we do not think it presents any real political risk owing to the popularity of the current government.

ACTIVITY: FRAGILE GROWTH

While the outlook for the global economy remains bleak in the new year, we believe GDP growth of 4.5% remains achievable, though this forecast depends crucially on private consumption remaining strong, exports reviving even moderately, and government making the appropriate policy responses.

Personal consumption, which grew by 6% in 2011, appears to be supported by a number of factors - rising remittances in peso terms, declining inflation, and credit activity sustained by high liquidity. However, as we had seen in the last global crisis, private spending can, despite sustaining factors, very easily be cut as a precautionary measure by households.

There should be some revival in exports, which dropped by 3.8% in real peso terms last year, as electronics and semiconductors fell 18.5% annually. Industry experts note the technology sector may well post double- digit gains this year by simply returning to 2010 volumes, which is quite likely as inventories have already begun to decline. But like domestic spending, it is clear that this recovery also hinges on the global economy not falling into another slump.

Much depends on whether government will be able to step up to the plate to give the economy the needed boost in 2012. We are quite optimistic about a revival in public spending based on recent actions of the budget department, which has already started to frontload expenditures, particularly on infrastructure. This should help counter an expected slowdown in private activity, with the real estate cycle, which industry experts say lasts six to seven years, already starting to turn.

We are less hopeful however about the ability of the trumpeted Public- Private Partnership (PPP) program, even in its hybrid form (i.e. tapping ODA loans), to jump-start private investment owing to continued difficulties in setting up and executing well-crafted projects that fit the government's governance framework and funders' requirements.

There currently seem to be signs of stronger activity with the government's leading economic indicator index predicting expansion in the first quarter on the back of stronger tourism, stock market and new business indicators; domestic credit still expanding at a double-digit rate; and corporate earnings expected by the market to grow by over 10% this year.

All in all, while there may be higher growth in 2012 and while upside surprises may even abound, there continue to be very potent downside risks on account of the uncertainty about the future of the global economy. Given the unknowns, from moderate growth this year, we are penciling in only a mild upturn in 2013, with GDP expected to grow by about 5%.

THE PUBLIC SECTOR: WAITING FOR AN UPGRADE

The national government's budget gap likely fell below 2% of GDP in 2011 (to about 1.6% in our estimate), or some two years earlier than originally planned by economic managers. The sudden shrinkage of the national deficit traced mainly to the current administration's housecleaning efforts, particularly an overhaul of the government's disbursement procedures that led to initial delays in public spending.

With the startup hitches of good governance reforms over, we anticipate a rebound in public spending this year. Apart from base effects, this belief is bolstered by what appears to be the Budget department's determination to reverse last year's trend. Officials recently announced they have already released nearly half of the budget for 2012, while unspent funds from last year would be carried over to the present period.

This should lead to an increase in the fiscal deficit this year. However, with revenues set to continue growing through administrative efforts, the national government should be able to meet its set deficit target (2.6% of GDP).

The Bureau of Internal Revenue (BIR) performed commendably in 2011, hitting targets despite low economic growth, and will likely be able to maintain its good showing this year. The Customs bureau, in contrast, has been missing its targets (by nearly P60 billion or about 0.6% of GDP) with documented reports of wholesale oil smuggling and of several thousands of containers disappearing, hallmarks of the past administration that remain unchecked today. Clearly, intensifying the anti-corruption drive in this agency and more skilled and experienced leadership could greatly improve the government's revenue haul.

Citing fiscal improvements, the country's economic managers continue to campaign for credit upgrades, where the hope is to see Philippine debt finally gaining investment grade status. Positive developments to this end include S&P's change in outlook from stable to positive and the recent successful borrowing of the Philippine government from the long-term debt market at just 5% or better than the rate fetched by Indonesia despite the latter's newly minted investment grade rating.

We believe a change in credit ratings is likely within the year, though not yet to a lower medium grade rating. Only Fitch currently rates Philippine issues at one notch below investment grade. S&P and Moody's are at two notches below. In any case, traders typically note that Philippine sovereigns have already been trading at investment grade levels, making a credit upgrade or change in outlook basically a catch-up move.

While rating agencies recognize the country's high external liquidity and relatively steady growth, they claim to be still looking for improvements in the fiscal and debt profile, specifically in terms of a steeper downward tilt of the debt trajectory. In our own computation, without a pronounced increase in sustainable revenue sources, the near-term reduction in the public-debt-to-GDP ratio will not be enough for the country to attain levels approaching those of similarly rated peers.

Tax effort has recently also been whittled down by the implementation of several revenue-eroding laws. Unfortunately, with Congress currently very much preoccupied with the impeachment trial of the Chief Justice, we are not too optimistic, at least in the near term, that progress will be made towards passing much-needed revenue-generating legislation, e.g. reform of tobacco and alcohol taxes and fiscal incentives rationalization, that can help bring back the ratio even to recent pre-crisis levels.

This article is an excerpt from the Feb. 11 report written by Margarita Gonzales and this columnist for GlobalSource, New York based network of independent analysts. Romeo L. Bernardo is a board director of the Institute for Development and Econometric Analysis.

Build it and they will fund

Business World
Introspective

Ever since President Aquino announced his administration's PPP thrust during the first State of the Nation Address, a lot of thinking has gone into creating an infrastructure fund for the Philippines. The premise behind creating such a fund is that the domestic financial market is failing to provide the right sort of financing that infrastructure projects need, i.e., long-term (think 25 years), fixed-rate and peso-denominated. Hence, investors end up with increased risks associated with rolling over short-term debts and/or unfavorable currency movements that raise their cost of capital and ultimately increase the cost of infrastructure investments.

While the premise was defensible, it was at the same time difficult to ignore criticisms raised against it in light of overwhelming interest among private sector players to mobilize their huge sums of idle money (P1.7 trillion parked in the BSP's Special Deposit Account) for infrastructure investments as well as the overtures of development partners pledging financial support of varying maturity, interest and currency profiles.

Moreover, the design and structure of the national government-driven proposed fund, which was envisioned to be catalytic yet commercially oriented, fell short of capturing the full support of either government or international financial institutions tapped to contribute to it. Many of these privately voiced the view that they can generate superior returns by directly investing in projects of their own choosing rather than in a pooled fund to be managed by a new, untested institution. Thus, despite much ado, the infrastructure fund to date remains on the drawing board.

While the nationally directed infrastructure fund continues to undergo tweaking, one of the chosen funders, the public pension fund Government Service Insurance System (GSIS), has announced a plan to create its own infrastructure fund. Unlike earlier versions with their confusing mandates of balancing developmental and commercial objectives, the GSIS-led fund is designed primarily to meet GSIS goals, i.e., diversification of fund assets, better matching of assets and liabilities as well as potentially higher returns.

Indeed, pension funds around the world have increasingly been attracted to infrastructure assets on the assumption and some evidence that these assets have a risk-return profile falling in between bonds and equities, i.e., they offer higher risk/returns vs. bonds while lower risk/returns vs. equity investments. Hence, from mere buying of listed stocks of companies in the infrastructure sector, pension funds have, depending on their individual risk appetite (which is also a function of their demographic profiles), moved into investing in listed or unlisted infrastructure funds managed by third parties, buying portions of infrastructure assets directly, or in the case of one Canadian pension fund, setting up an investment arm dedicated to finding suitable infrastructure assets. Many have opted to invest not only domestically but internationally. Increasingly too, pension funds are not only looking at mature assets with stable cash flows but a recent The Economist article (from which the title of this piece is borrowed) reported on a plan in the UK for pensions to invest in higher-risk greenfield assets.

This appears to be the thinking behind the GSIS infrastructure fund as well. In light of the Aquino administration's ongoing efforts to develop a pipeline of PPP projects, there are significant opportunities for an entity that takes a long view of investment returns to participate in the program. More so if the entity is well-placed to handle political and regulatory risks that investors typically associate with infrastructure projects in the Philippines.

News reports reveal that the initiative for the infrastructure fund is being pursued by GSIS with the Asian Development Bank and International Finance Corp., the private sector arm of the World Bank, as cosponsors (Infrastructure fund eyed, BusinessWorld, Nov. 16, 2011). This brings international professional expertise in finance and the highest degree of governance in its management, and insulates it from harmful political interventions beyond the term of this administration, a clear commitment to structural reform of a lasting nature which deserves public commendation. Moreover, it is expected that fund management will be outsourced to professional infrastructure experts with global track record which will help ensure that investment decisions are anchored on arms-length, transparent and non-political criteria and processes.

On the face of it, investing in infrastructure is a wise move for GSIS which needs to diversify its investment portfolio. The pension fund, with an asset base of about P600 billion (7% of GDP) has limited investment options. Based on its 2009 financial statements, over three-fourths of its investments was equally divided in only two asset types - government securities and loans, largely to members (and this was at a time when a portion of its portfolio was still invested overseas). Given its size, forays into the relatively small and illiquid local stock market through direct share purchases had tended to attract governance-related controversies. Likewise, the attempt to diversify its portfolio internationally in 2008 was short-lived as it coincided with the global financial crisis. The funds were redeemed last year and invested locally.

Such a diversification move is also in line with the recommendations of an international team of consultants commissioned by the World Bank and the Department of Finance that included pension gurus Estelle James and Alberto Musalem. Filipino actuary Ernie Reyes, financial analyst Christine Tang and I were privileged to join that team. Our 200-page report, Structural and governance reform of the Philippine pension system, 2007 had this to say on the need for diversification:

Diversification of portfolios is a significant issue for each institution (referring to GSIS, SSS, et al.). A basic problem is the diversification of investments within the relatively few opportunities offered by the local financial markets (both commercial and government securities). Pension related institutions already play a substantial role in the Philippines' capital market, with a capacity to move market prices. Part of the problem is that pension institutions tend to hold and manage stocks in individual companies, so even if their share in the overall stock market is not so great, they are able to move market prices for specific companies. Greater diversification domestically, and investing through pooled instruments would reduce the impact of investment by these institutions on price movements.

Romeo L. Bernardo is managing director of Lazaro Bernardo Tiu & Associates, Inc., Philippine advisor of GlobalSource, and a board member of the Institute for Development and Econometric Analysis, Inc.

Build it and they will fund

Business World
Introspective


Ever since President Aquino announced his administration's PPP thrust during the first State of the Nation Address, a lot of thinking has gone into creating an infrastructure fund for the Philippines. The premise behind creating such a fund is that the domestic financial market is failing to provide the right sort of financing that infrastructure projects need, i.e., long-term (think 25 years), fixed-rate and peso-denominated. Hence, investors end up with increased risks associated with rolling over short-term debts and/or unfavorable currency movements that raise their cost of capital and ultimately increase the cost of infrastructure investments.

While the premise was defensible, it was at the same time difficult to ignore criticisms raised against it in light of overwhelming interest among private sector players to mobilize their huge sums of idle money (P1.7 trillion parked in the BSP's Special Deposit Account) for infrastructure investments as well as the overtures of development partners pledging financial support of varying maturity, interest and currency profiles.

Moreover, the design and structure of the national government-driven proposed fund, which was envisioned to be catalytic yet commercially oriented, fell short of capturing the full support of either government or international financial institutions tapped to contribute to it. Many of these privately voiced the view that they can generate superior returns by directly investing in projects of their own choosing rather than in a pooled fund to be managed by a new, untested institution. Thus, despite much ado, the infrastructure fund to date remains on the drawing board.

While the nationally directed infrastructure fund continues to undergo tweaking, one of the chosen funders, the public pension fund Government Service Insurance System (GSIS), has announced a plan to create its own infrastructure fund. Unlike earlier versions with their confusing mandates of balancing developmental and commercial objectives, the GSIS-led fund is designed primarily to meet GSIS goals, i.e., diversification of fund assets, better matching of assets and liabilities as well as potentially higher returns.

Indeed, pension funds around the world have increasingly been attracted to infrastructure assets on the assumption and some evidence that these assets have a risk-return profile falling in between bonds and equities, i.e., they offer higher risk/returns vs. bonds while lower risk/returns vs. equity investments. Hence, from mere buying of listed stocks of companies in the infrastructure sector, pension funds have, depending on their individual risk appetite (which is also a function of their demographic profiles), moved into investing in listed or unlisted infrastructure funds managed by third parties, buying portions of infrastructure assets directly, or in the case of one Canadian pension fund, setting up an investment arm dedicated to finding suitable infrastructure assets. Many have opted to invest not only domestically but internationally. Increasingly too, pension funds are not only looking at mature assets with stable cash flows but a recent The Economist article (from which the title of this piece is borrowed) reported on a plan in the UK for pensions to invest in higher-risk greenfield assets.

This appears to be the thinking behind the GSIS infrastructure fund as well. In light of the Aquino administration's ongoing efforts to develop a pipeline of PPP projects, there are significant opportunities for an entity that takes a long view of investment returns to participate in the program. More so if the entity is well-placed to handle political and regulatory risks that investors typically associate with infrastructure projects in the Philippines.

News reports reveal that the initiative for the infrastructure fund is being pursued by GSIS with the Asian Development Bank and International Finance Corp., the private sector arm of the World Bank, as cosponsors (Infrastructure fund eyed, BusinessWorld, Nov. 16, 2011). This brings international professional expertise in finance and the highest degree of governance in its management, and insulates it from harmful political interventions beyond the term of this administration, a clear commitment to structural reform of a lasting nature which deserves public commendation. Moreover, it is expected that fund management will be outsourced to professional infrastructure experts with global track record which will help ensure that investment decisions are anchored on arms-length, transparent and non-political criteria and processes.

On the face of it, investing in infrastructure is a wise move for GSIS which needs to diversify its investment portfolio. The pension fund, with an asset base of about P600 billion (7% of GDP) has limited investment options. Based on its 2009 financial statements, over three-fourths of its investments was equally divided in only two asset types - government securities and loans, largely to members (and this was at a time when a portion of its portfolio was still invested overseas). Given its size, forays into the relatively small and illiquid local stock market through direct share purchases had tended to attract governance-related controversies. Likewise, the attempt to diversify its portfolio internationally in 2008 was short-lived as it coincided with the global financial crisis. The funds were redeemed last year and invested locally.

Such a diversification move is also in line with the recommendations of an international team of consultants commissioned by the World Bank and the Department of Finance that included pension gurus Estelle James and Alberto Musalem. Filipino actuary Ernie Reyes, financial analyst Christine Tang and I were privileged to join that team. Our 200-page report, Structural and governance reform of the Philippine pension system, 2007 had this to say on the need for diversification:

Diversification of portfolios is a significant issue for each institution (referring to GSIS, SSS, et al.). A basic problem is the diversification of investments within the relatively few opportunities offered by the local financial markets (both commercial and government securities). Pension related institutions already play a substantial role in the Philippines' capital market, with a capacity to move market prices. Part of the problem is that pension institutions tend to hold and manage stocks in individual companies, so even if their share in the overall stock market is not so great, they are able to move market prices for specific companies. Greater diversification domestically, and investing through pooled instruments would reduce the impact of investment by these institutions on price movements.

Romeo L. Bernardo is managing director of Lazaro Bernardo Tiu & Associates, Inc., Philippine advisor of GlobalSource, and a board member of the Institute for Development and Econometric Analysis, Inc.

Resilient, not immune

Business World
Introspective

The global outlook has become infinitely gloomier over the past couple of months, with the euro zone in a sovereign debt crisis and the US in what could be another recessionary environment. This puts a heavy cloud over the Philippine economy, whose fortunes are still in some ways tied to these countries, and opens up another period of uncertain growth.

In our central scenario, assuming global financial troubles can be contained, we bring down our growth forecasts from 4.8% to 4.3% in 2011 and from 5.5% to 4.8% in 2012. Activity would be mainly consumption-driven in our projections, with net exports likely to decline this year and not see a major resurgence the next. At the same time, government spending especially on infrastructure may remain weak, limiting the country's investment growth, though should eventually rebound.

In the worst case where European debt troubles coupled by US weakness lead to another global financial crisis of the same scale as 2008, the Philippines could remain as resilient to recession and financial volatility as it had been back then. This is in light of robust domestic demand, continued remittance and BPO inflows, historically high FX reserves, a generally healthy bank sector, and greater fiscal space this time to help counter a downturn in the real economy.

Reflective of the sound fundamentals of the country are the recent string of credit upgrades by international rating agencies and a jump in world competitiveness ranking (up by 10 slots in the World Economic Forum's latest Global Competitiveness report). These observers noted the country's strong macroeconomic management that has led to improvements in the country's debt situation, narrower interest rate spreads, and reined-in inflation.

In our best scenario, there could be a brightening in the outlook for the world economy if international efforts succeed at preventing a financial contagion coming from the euro zone and if effective measures to stimulate the US economy are put in place. Domestically, we could see a bump in economic activity if government actually succeeds in accelerating infrastructure spending as it hopes to, though the contribution of PPP to this will not likely be close to nil.

We had already cut our growth forecast for 2011 to 4.8% in our last quarterly report considering the threat posed at the time by surging global oil and food prices, weakened purchasing power of dollar remittances due to peso appreciation, and government's odd spending restraint. Supply-chain disruptions brought about by Japan's tsunami and nuclear crisis had also further weakened our outlook for exports, then expected to naturally decelerate from a recovery pace.

Based on first half performance (4.6% in 1Q2011, as revised, and 3.4% in 2Q2011), even this downscaled number has begun to look a bit optimistic, as it required the economy to grow upwards of 5.5% in the second half. The more likely figure, in our view, would be about 4.3% in 2011 (and around 4.8% in 2012) for a few important reasons.

First, while the government has vowed to redouble its spending and meet spending targets before the year ends, it may find it increasingly hard to do so. The big surprise during the second quarter had been the drop in public construction outlays, which fell by over 40%, a drastic reduction even coming from an election year. Fiscal accounts show that government (non-interest) spending during the first six months fell short of what was programmed by nearly P120 billion (about 17.5%) as wasteful projects were shelved and operating expenses cut. This presumably barred any front- loading to take place and make the most of the summer months as had been trumpeted by economic managers after early passage of the budget.

Second, in relation to this, we continue to see slow movement in the public-private partnership (PPP) program which should further stall the country's much-needed infrastructure boost. As we had discussed in earlier reports, delays traced to the lack of well-crafted feasibility studies; weak technical and institutional capacity; and overly tight scrutiny of unsolicited proposals, especially those put in the investment pipeline by the previous administration. With government's housecleaning efforts beginning to dilute investor interest rather than promote it, in the short run at least, we are doubtful PPP projects would be able to take off anytime soon.

Even the new scheme recently proposed for mass transport projects under the PPP may not yield the desired quick results. This approach, which hopes to tap cheap development loans to build the fixed component (e.g., tracks) while allowing private firms to bid for providing the rest of the system, including rolling stock and operations and maintenance, may be even harder and take longer to pull off as it introduces another layer of complexity in reconciling policies and procedural requirements of government, official funders, and private investors.

Third, the world economy has already entered what the IMF calls a dangerous new phase marked by weakened activity especially in advanced economies (the US and in Europe), falling confidence, and growing downside risks. This means another period of uncertain growth for the Philippines in view of the potential impact on exports and remittances.

On the upside, however, inflation risk has abated which helps support consumer demand and also lessens the unspoken bias for peso appreciation. Remittances while slower than expected continue to be resilient at 6.3% in the first semester. The government has vowed to make use of the extra fiscal space created and frontload spending on projects due for implementation next year.

Credit activity remains high on account of liquidity created by continued portfolio flows. Notwithstanding minimal holdings to the new troubled euro zone (only 1.4 % of total assets) and high concentration of assets in Philippine government paper and a handful of domestic conglomerates, banks are generally healthy. As in the last global financial crisis episode, we believe the Philippine economy will likely remain resilient compared to many of its neighbors in the region.

This article is an excerpt from an October 3 report written by Margarita Gonzales and this columnist for GlobalSouce, a New York based network of independent analysts. Mr. Bernardo is a board director of the Institute for Development and Econometric Analysis.

De-monopolizing telecommunications

Business World
Introspective

Two key issues on telecommunications have lately hogged business headlines: a) the PLDT-Digitel Merger, and b) the proposed National Broadband project. Both these issues test the clarity of government's development vision and its commitment to sound regulation and competition policy. Its decisions will impact not only the efficiency of delivery of telephony and data services to both private users and government, but our country's competitiveness and development over the long run.

Let me start with a disclosure - I am a board director of Globe Telecom. In a previous life, though, for over two decades, I was a civil servant at the Department of Finance and in multilateral institutions. There, I had a good view of the politics of economic reform, especially as undersecretary under the reform-minded Aquino 1 and Ramos administrations. With this background, I was asked, together with my colleague Christine Tang, to do a case study on the subject by the World Bank Growth Commission. (The Political Economy of Reform during the Ramos Administration, link 
http://www.growthcommission.org/storage/cgdev/documents/gcwp039web.pdf). A key chapter, the De-monopolization of Telecommunications, documents the political and regulatory fortitude needed to dislodge entrenched interests.

THEN
It starts with a quote attributed to Singapore Senior Minister Lee Kuan Yew in 1992: The Philippines is a country where 98 percent of the residents are waiting for a telephone and the other 2 percent are waiting for a dial tone. Indeed it best describes the situation of the domestic telecommunications industry in 1992. An estimated 800,000 applicants, 75% in the country's capital, Metro Manila, were queuing for a telephone line. At the time, the Philippine Long Distance Telephone Company (PLDT), which owned the only nationwide transmission backbone, was a virtual monopoly, controlling over 90% of the country's telephone lines. Its controlling shareholder was politically well connected, its influence extending across the three branches of government as well as the media.

None of the telephone companies operating at the time were in a position to challenge PLDT's leadership. Following news accounts, PLDT, instead of expanding its network to meet service demand, spent heavily for the protection of its market share. For instance, when the previous government decided to open up the sector to competition, reports indicate that PLDT was able to secure as needed favorable legal rulings to block prospective entrants. It had apparently been a risky venture for the president to go after PLDT. If he loses in this duel, the president's credibility as a strong leader will be severely dented, observed one report at the time.

Nevertheless, the Ramos administration proceeded to pry the sector open with various tactics... from encouraging the formation of consumer groups that took to the streets and clamored for change, to boardroom battles. One case reportedly led to the resignation of a Supreme Court justice whose decision favoring PLDT was alleged to have been written by a PLDT lawyer.

As a result, the twin executive orders (EO) that the president issued in 1993 opened the floodgates to investments in the sector. By the time Congress passed legislation largely echoing provisions of the two executive orders, the country's teledensity had doubled and PLDT had already embarked on a zero backlog program.
Our 2008 paper continues: Fifteen years on, the benefits of the reform may be seen in (i) increased access to telecommunication services, with teledensity in the cellular mobile telephone service (CMTS) segment of the market reaching 50 per 100 population in 2007; (ii) increased market competition with the entry of more players representing domestic and foreign interests; (iii) the rise of new growth industries such as business process outsourcing; and (iv) a whole new range of business solutions using cellular mobile telephone technology that caters to the retail client, such as money transfers for overseas workers. An interesting, perhaps ironic turn of events is that PLDT, which had strongly resisted the reform, managed to shape up and emerged a big winner of the reform....

NOW
Fast forward to the present. PLDT, under new controlling ownership, proposes to acquire Sun-Digitel, threatening to reestablish a near monopoly situation. Together, the combined companies will control 73% of the market. Even more tellingly, the combined PLDT-Digitel will control three out of the four blocks of telephone frequencies - 75% of the highway for delivering the service. This level of control is against the spirit, if not a direct contravention of the Ramos era EO which sought to limit each telco to only one bloc.

This issue has been recently deliberated in the appropriate Senate committee whose findings we await, and is now under consideration by the NTC. What was made clear during the hearings is that nowhere in the world is such a degree of concentration allowed without putting effective limitations on the dominant provider. For example, in the US, the recent AT &T/T-Mobile merger triggered alarm bells in the US top anti-trust agency even though both carriers combined subscriber bases would amount to a little less than 44% of the total wireless market. Well established regulatory regimes everywhere else would have done the same.

Widely followed analyst Boo Chanco wrote in his latest column about the ill-advised revival of the National Broadband project. He provided yet another reason why we need to strengthen competition in the industry. To combat the fear of Secretary Montejo that our private telcos might overcharge government for telco services, he cited that two noted economists (Dr. Raul Fabella and Dr. Noel de Dios) at that meeting with the secretary urged government to make sure no one of the private telcos gain even near monopoly powers. Government must exercise its function and duty to regulate the telcos not just to get the prices they are seeking for government operations but for the sake of the consumers as well.

I am hopeful that the present regulators - and the national leadership - will be equal to the challenge of the times.

Mr. Romeo Bernardo is a Philippine GlobalSource Partners advisor, managing director of Lazaro Bernardo Tiu & Associates, Inc. and a board member of The Institute for Development and Econometric Analysis, Inc, (IDEA).