Crediting the Upgrade

The Makati Business Club which by and large supported the candidacy of PNoy paid him homage in his first year in office by crediting his administration for the numerous upgrades the country received from ratings agencies, but the underlying cause might be found elsewhere.

The MBC spoke of the way in which the administration fostered macroeconomic stability and investor confidence. Macroeconomic stability of course depends on both the national government’s fiscal policies (how it earns and spends money) and the Bangko Sentral’s monetary policies (how it regulates and intervenes in the financial system).

Although some credit is due to PNoy for the mandate he received which led to the smooth turnover of power and for not destabilizing markets or the economy, there is a more fundamental reason why rating agencies gave us an upgrade. The following chart provides a big clue as to what it was.

For the first time, the nation’s gross international reserves exceed its external debt obligations (both public and private). As of March 2011, they stood at 66 billion US dollars compared to the external obligations (both private and public) amounting to 61 billion. The reserves have been parked in fixed investments overseas, mainly US treasury notes I would imagine making the country a net lender to the rest of the world.

An examination of our balance of payments (the flow of payment in and out of the country) will tell us that the growth in our dollar reserves is due mainly to dollar remittances by overseas Filipinos and the inflow of portfolio investments into our stock market. Foreign income from our services industries contributes to it as well albeit minimally, while our export of goods continues to lag our import (see chart below).

Foreign direct investments continue to be a pittance compared to our overall economy and to our neighbors. Foreign investments are mainly being channeled into domestic firms listed in our stock market. Assuming these portfolio investments are weighted in accordance with the Philippine Stock Index (a basket of the top listed companies), these flows simply reinforce the current industry structure (not to mention the pecking order). It also runs the risk of creating a property-debt bubble in a few years.

Last year when the country posted a fourteen and a half billion dollar balance of payments surplus (a net inflow of foreign currency), I posed the question what should it do with it. The appreciation of the peso is hurting our exporters and the families of overseas Filipinos despite efforts by the BSP to stem the rise.

The other related issue has to do with where the foreign remittances are being spent: mainly on consumer goods and real property. Banks have also been benefiting from these remittances, but have not found a productive use for them. The accumulation of savings has outstripped investments as shown in the following chart making the Philippines a net saving economy rather than a net borrowing one.

This leads me to think, given that the country has extra liquidity, why has there been no effort made to channel these resources to where they are needed the most? The problem with investments in the Philippines has nothing to do with the supply side any longer (or the availability of capital), but has more to do with the demand side (or the availability and attractiveness of projects to invest in).

The Western thinking MBC might contend that the reason why investors shy away is because of the poor economic and business environment, poor governance and inadequate institutions like bad laws, regulation and red-tape. There is some truth to that. The flow of ‘hot money’ into the stock exchange however tells me that investors don’t see bad governance as a major hindrance to the growth of privately owned companies.

Causes and Effects

The other main cause for weak investment flows could be a simple lack of information about the sectors that are worth investing in. The free rider problem where everyone is waiting until somebody else proves an idea is worth pursuing and then cashing in when it becomes viable could possibly be one major factor in this.

A third possible reason for the lack of investment is simply the fact that our government does not have enough capacity to cope with its infrastructure backlog. This is primarily due to the inadequacy of the tax system to raise sufficient revenues to fund them. While private investors can fill the gap somewhat through the build, operate, transfer scheme, they cannot fill it completely as the unmet demand for schools and hospitals will attest.

There are basically three policy implications and recommendations that follow from this discussion.

  1. Improve regulatory quality, bureaucratic capacity and predictability.
  2. Improve entrepreneurial risk-taking capacity.
  3. Improve capacity for infrastructure funding.

Enough has been written with regards to the first recommendation, and the MBC is already involved in that effort. What I would like to do is focus on the last two recommendations as I have some ideas on how to pursue them.

Hurdles and Hoops

The first hurdle of course is where to source the funding. As the the preceding analysis has shown, the nation has a net stock of foreign reserves in excess of its external obligations. It has gone up by about 4 billion dollars per year on average in the last four years. This is about the size of the public sector deficit (2% of GDP).

To prevent the peso from rising, what the government could do is coordinate with the BSP so that it could issue treasury notes and have the BSP purchase them (much in the same way the US Federal Reserve bought US treasury securities under Bernanke). This would lower the borrowing cost of the government given the BSP’s views that the country is actually of investment grade.

The proceeds of this could either go to funding the fiscal deficit, or as we reach a balanced budget over the next two to three years be used to set up two funds. The first could be called the Philippine Enterprise Innovation Fund or PEIF. The second could be called the Regional Philippine Infrastructure Fund or RPIF.

The first fund would either go towards funding Public Private Partnerships involving start-ups or be given as outright grants or concessionary loans to projects that would allow us to diversify our industry sectors or bring about the commercialization of new innovative business models.

The second would go to fund infrastructure projects in the regions where public investment is lacking. It could help bridge the education and health infrastructure gaps or to community projects or even to social and environmental projects. Priority could be given to remote places where the gaps are most severe.

Where credit is due

In crediting the upgrade to PNoy, the current problem of forced savings by the government whose surplus fetish makes it more subservient to the bond market than to the needs of the people is endorsed. It is a self-congratulatory remark to the business community as well which has failed to fund risky entrepreneurial projects that could be the source of future growth.

While the government’s good governance agenda should be continued in improving the overall environment for doing business, the capacity of the public sector in addressing ‘market failures’ and in providing much needed economic, social and environmental infrastructure must be boosted even more.

Doy Santos aka The Cusp

Doy Santos is an international development consultant who shuttles between Australia and the Philippines. He maintains a blog called The Cusp: A discussion of new thinking, new schools of thought and fresh ideas on public policy ( and tweets as @thecusponline. He holds a Master in Development Economics from the University of the Philippines and an MS in Public Policy from Carnegie Mellon University.

  • J_ag
    • I found that article by Ben Diokno (What if PPP projects don’t take off?) particularly poignant. It just highlights what is wrong with the current development strategy of the Aquino administration. He has echoed the sentiment that I have expressed here that the government has no Plan B if things don’t work out as planned.

      Which is why I have been proposing alternative development strategies. Unfortunately, I don’t see or hear anyone in policy circles making similar proposals. The article also highlights the problems over foreign investor confidence particularly when we compare our first quarter performance with other ASEAN countries (save for Thailand which has had some political turbulence).

      • J_ag

        It is a scary situation when in the near medium term , 2-3 years the current low interest rate regimen in the global economy will shift and shift quickly.

        The Philippines once again will be left at the starting line.

  • J_ag
  • J_ag

    Please note that banks do not simply sit on dollar deposits for which they pay interest on. They are part of the banks own dollar holdings which the banks invest in the bond markets here. Corporations and the government do issue debt paper. Try to distinguish between reserves, bank holdings and client deposits. All of this are invested.

    There are reserve requirements I believe for banks holdings of dollar deposits.

    This government is unprepared and super cautious in its announced job ahead.

  • J_ag

    “The Bangko Sentral ng Pilipinas (BSP) said the country’s foreign debt stock was also 1.5% more than the $60 billion recorded as of end-2010.”

    “External debt consists of borrowings by Philippine residents from nonresidents that are approved by and registered with BSP. ” Business World

    Domestic Borrowings in foreign currencies are not included in the external debt total. Corporations and individuals are allowed to own foreign currencies in the FCDU accounts. The total of these accounts are over $20 billion.

    That would mean the country actually does not have a net surplus of dollars in its name. In this age of financial globalization and capital account liberalization there is not such thing as foreign debt.

    The Philippines to a very small degree manages its so called macro economic policy because of this. Doy Santos, Say Tetangco and Purissima do not set the interest rates for the dollar, yen or euro.

    Plus neither Keynes nor Freidman monetarist policies can work here.

    What determine our growth rates to a great degree are the Federal Reserve and Mr. Bond Market.

    The U.S. treasury can borrow at almost zero to half a point for up to two years. Banks also can borrow from one another at almost zero rates. The Fed has halted its buying of U.S. treasuries. Since the U.S. economy like a heart patient recovering from a serious stroke still cannot support itself through private spending a tidal wave of funds are still engulfing the world.

    Our Factor income from abroad minus factor income leaving the country (factor income means OFW plus income from resident investments abroad minus foreign income from expats and foreign investments and profit repatriation) combined is plugging our chronic trade deficits.

    Our manufacturing base remains narrow shallow and hollow. We manufacture goods at the periphery of what we should actually be manufacturing.. (Mainly assembly with foreign capital goods technology.)

    Pinoys should accept the fact that we are not in charge of our economic destiny.

    The massive “printing of money” by the U.S. and the EU are meant to create inflation to counter deflation. While emerging markets who have massive trade surplus are supposed to revalue their currencies to lower inflation.

    If the BSP stopped sanitizing the flow of funds through the SDA our forex rate would cause the dollar to collapse making imports in particular oil cheaper.

    • The Businessworld quote you referenced is accurate. Our external debts as at the end of March 2011 is $60.9b up 1.5% from December last year (in the article, I rounded this up to $61b).

      As for FCDU’s, the loans as at the end of Q1 2011 was $5.5b down from $5.8b last December, but deposits were at $24.7b, which leaves us with a comfortable margin of reserves.

      I agree with your view with regards to Manufacturing policy or the lack of it. The article points out government’s role in assisting with the process of self-discovery, the term used by Rodrik (whose article I linked to) to denote the process of applying foreign technology locally and determining what the cost structure of it would be and whether it is feasible.

      This is why I put forth two proposals for dealing with both the currency appreciation as well as the need for greater entrepreneurial self-discovery. I am curious to hear your views on this.