A Philippine Sovereign Wealth Fund

The Philippines is suffering from a rare form of “Dutch disease”, the negative consequences of a rapid rise in income normally associated with the export of natural reserves. In our case, the income comes from our export of labour. Overseas remittances rising every year swell our foreign currency reserves. The peso appreciates as a result. This diminishes the global competitiveness of our manufacturing sector with adverse implications for domestic employment.

Meanwhile government keeps borrowing from international markets to finance its chronic budget deficits. This contributes to the upward pressure on the domestic currency as more dollars flow in to purchase government securities. To keep its borrowing down and make credit rating agencies happy, government constrains its spending. It wants to rely on public-private partnerships (PPP) to provide infrastructure which are both time-consuming to arrange and limited in scope.

As it postpones development spending credit rating upgrades keep coming. Each time this happens, fund managers around the world increase the flow of “hot money” into the stock market, thus contributing to more upward pressure on the peso. Property developers also cash in as the value of residential and commercial assets appreciates with the rising peso, which creates even more demand for new development.

The families that receive remittances on the other hand suffer as the purchasing power of the dollar declines. And due to their dependence on these transfers, the income that families receive goes mostly to household expenditures. Very little is invested in productive activity. And when it is, the investment normally goes into retail or transport enterprises, which earn very marginal returns.

For the rest of the population, finding a job is a struggle. Life is hard as there are not enough opportunities that come by due to a dearth of fixed private capital expenditures on plant and equipment let alone research and development. Most of the inflows go to short-term investments, i.e. the stock market, or to fund property purchases, which results in very little job generation outside the construction industry which demands casual employment due to the seasonality of its activity.

This in a nutshell is the problem that confounds the Philippines.

Foreign remittances for the twelve months to January 2012 hit $20 billion according to the World Bank. Remittances for the first ten months of 2012 have already equaled that amount according to central bank figures (with the Asian Bankers Association estimating the real amount to be in the order of $27 billion). This was close to 90 per cent of the Bureau of Internal Revenue”s total tax collections for 2011, and would have been enough to finance that year’s budget deficit four times over. As of November 2012, the country’s gross international reserves (GIR) stood at $84 billion exceeding the BSP’s full year estimate of $78 billion.

This was enough to cover our imports for a full year or to settle all short-term debt obligations 12 times based on original maturity and 6.8 times based on residual maturity (that is short-term loans based on original maturity plus principal payments on medium- and long-term loans of both private and public sectors falling due in the next 12 months).

In fact back in June 2012 when the GIR stood at $76.1 billion, the country’s external debts belonging to both the public and private sectors stood at $62.5 billion. That means the BSP had enough to settle all external obligations and still have roughly $14 billion left over.

The two charts below show what has happened over the past decade. The first one shows that after a rocky first half, the country has been producing consistent balance of payments (BoP) surpluses averaging about 3.8 per cent of GDP from 2005-2011. That is the inward flow of foreign currency exceeded the outward flow by the said ratio. A quick rule of thumb is that 1 per cent of GDP is roughly $2.5 billion or Php100 billion.

So on average, the annual surplus has been about Php380 billion during the past six years. The average BoP surplus is therefore more than enough to accommodate government’s annual revenue shortfall averaging 1.11 per cent a year. The second chart shows the effect these surpluses have had on our GIR. From 2001 to 2011, it has grown on average by 16.7 per cent. Up until 2005, you can see that the line is pretty flat. Afterwards it rises steeply. This means that a tipping point in the flow of overseas remittances occurred back then which placed our BoP structurally in surplus territory from that point on.

Surpluses and deficits, in per cent of GDP

No wonder bond markets have had such confidence in the Philippines. As the saying in business goes, banks will only offer you credit when you don’t need it. The question is do we just keep accumulating these reserves knowing the problems they create for our economy? Or do we actually put the excess funds to good use by investing in the country’s development?

As the title of the piece suggests, we could set up a sovereign wealth fund (SWF) with our excess reserves. The $14 billion mentioned above, which by the end of the year will probably be $15 billion would be the seed money. That is enough to double our infrastructure spending which is currently 1.5 per cent of GDP to 3 per cent, much closer to the recommended 5 per cent, over the next four years. With that added spending, the government could easily meet its aspirational stretch target of growing the economy by 7-8 per cent a year.

Every year, depending on how well our balance of payments performs, we could just keep adding to the SWF. Assuming that the government’s new revenue measures and fiscal consolidation will mean an annual deficit of about 1 per cent of GDP and that the annual BoP surplus remains at 3 per cent of GDP, there would be enough to fund government’s deficit and set aside another 1 per cent to augment the SWF, with the remaining 1 per cent going to GIR.

But we are getting ahead of ourselves. Let us first define what is a SWF? According to the Sovereign Wealth Fund Institute, it is

a state-owned investment fund or entity that is commonly established from balance of payments surpluses, official foreign currency operations, the proceeds of privatisations, governmental transfer payments, fiscal surpluses, and/or receipts from resource exports.

The Institute cites some “interesting facts” about SWFs, namely that some of them “invest indirectly in domestic industries” and that “they tend to prefer returns over liquidity, thus they have a higher risk tolerance than traditional foreign exchange reserves. Most often SWFs receive their initial capital through “commodity exports, either taxed or owned by the government” or through “transfers of assets from official foreign exchange reserves”.

There are about US$5.1 trillion invested in SWFs globally. About three of every five dollars come from oil and gas exports, the remainder from other sources. The size of funds varies from as little as US$300 million for Indonesia to as large as US$664 billion for Norway. Of the 64 SWFs that currently exist, 39 were established since 2000.

Some have argued that the Bangko Sentral is restricted by its charter, RA 7653, the Central Bank Act, from investing in instruments other than Triple-A rated bonds of foreign governments. At the time this law was passed, the problem facing the country was chronic balance of payments deficits. More transfers out rather than in were being made.

The BSP is tasked under the law with maintaining international monetary stability in the country. Part of this according to Article II, Section 64 of the law is “to preserve the international value of the peso and to maintain its convertibility into other freely convertible currencies”.

To maintain such stability, Section 65 says that “the Bangko Sentral shall maintain international reserves adequate to meet any foreseeable net demands on the Bangko Sentral for foreign currencies”. It would have to judge for itself the adequacy of these reserves based on “prospective receipts and payments of foreign exchange by the Philippines”.

Finally, Section 66 lays out the composition of such reserves which it says “may include but shall not be limited to” gold and other assets that took the form of “documents and instruments customarily employed for the international transfer of funds; demand and time deposits in central banks, treasuries and commercial banks abroad; foreign government securities; and foreign notes and coins”.

So why did the central bank governor offer in September of 2011 to purchase Philippine treasury using its dollar reserves given that these notes are not Triple-A rated? Well, he had probably realised as I had back in November 2010 that the Bank already had an adequate supply of reserves to meet international obligations.

Given that the law says nothing about what to do if the Bank were to have more than a sufficient level of reserves we can say that the Bank is sailing in unchartered waters. If the law does not specify what it should do in such a situation, then it should be left to the discretion of its board to decide on how best to deal with it.

Currently, the return on short-term US treasury notes is between 0 and 0.25 per cent, negative in real terms, meaning that the Bank is paying the US government to borrow from its reserves. And the Fed has said that it plans to keep interest rates as low as they are for the foreseeable future until the US unemployment rate goes under 6.5 per cent (it is currently at 7.7 per cent). If the BSP lent its excess reserves to the Philippine government, it would gain a better return and preserve the value of its assets.

Now that we have cleared the financial viability and legality issues, what would be the purpose of a Philippine SWF? The nature and purpose of SWFs are varied, but in the Philippines it might be to do the following (as adapted from the SWF Institute):

  • Protect and stabilise the budget and economy from excess volatility in revenues/exports
  • Diversify our industry sector to make growth more inclusive and robust
  • Earn greater returns than on foreign exchange reserves
  • Assist monetary authorities dissipate unwanted liquidity
  • Increase savings for future generations, or
  • Fund social and economic development.

Given the need to boost productivity and improve competitiveness, addressing the infrastructure backlog would be the most obvious answer. The public-private partnership projects would be a good initial source of demand for funding as these projects are designed to earn a market rate of return for the investor. Another possibility would be for the SWF to enter into joint-ventures with mining firms for the joint-exploration and production of oil and other commodities. This would ensure that we received a larger share of the benefits from such operations.

A third possibility would be to fund innovation through government procurement, business incubators, industry clusters, and competitions aimed at the commercialisation of ideas. Government could serve as a catalyst in the germination of new activity around key areas of specialisation that the country has already exhibited proficiencies in. The expansion of our semiconductor and electronics industry into higher value adding activities could be one priority. The growth of agribusinesses into higher yield crops and again value adding processes could be another. A fourth priority could be the generation of clean technology and renewable energy.

Finally, beyond just the economic, financial, legal and commercial viability, there is the political viability of doing this. Creating a Philippine SWF would be politically astute as it would be seen as the Aquino administration’s unique contribution to the development of the country. The vice president has also expressed his support for the concept of using foreign reserves for development. This means that the measure would have the support of both leaders and their coalition partners in both houses of Congress.

Beyond that, the consensus formed by our leaders would mark the first time a remittance dependent nation’s government deliberately leveraged the income derived from its work force overseas to channel resources into highly productive activity back home. It would be a shift in the development paradigm of such countries and provide a model for them to follow. Just as conditional cash transfers were forged through a consensus among Mexico’s and Brazil’s leaders as a way to alleviate poverty, the Philippine consensus would provide a path for low income households out of poverty and into the middle class by providing jobs to people of low skills through the fruits of their countrymen’s sacrifice overseas.

If we don’t recognise the opportunity that lies before us in this regard, then when our overseas workers return home, all their hard work may come to nothing as their children will then have to go abroad because there would be no jobs left for them here. With the Aquino government’s good governance credentials, it should be able to shape the probity and prudential measures needed to ensure that the SWF is properly managed and its funds transparently and judiciously utilised for public benefit. This would prove that good governance is indeed good economics and that the righteous path can create in the Philippines opportunities not just for some but for all.

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 (www.thecusponline.org) 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.

  • ricelander

    Great idea!

  • Manuel Buencamino

    At first I thought the SWF you had in mind would be like those SWFs in other countries that invest abroad and some were burned by the 2008 crisis. But your SWF keeps the money at home. I love it. There will be risks but risks are part of any investment. And since you will spend the money here then it will not be “lost” in the sense that those foreign SWFs lost their money. So go for it. Write a workable proposal and submit it to the proper authorities. I volunteer to help in any way I can.

    • Would a discussion paper scoping out the alternatives with a preferred option be more useful at this point?

      • manuelbuencamino

        I don’t know how these things are done. I thought I read a discussion paper. But how ever it’s done your post should get people talking and thinking.

        • Thanks, well with your help, perhaps a lot more will be talking and thinking about it.

  • GabbyD

    what exactly do you have in mind when it comes to investment in development by a potential philippine SWF?

    • Are you asking for specific projects? Or are you asking this to find out what the criteria should be for funding them? The actual prudential measures can be worked out to ensure there is a genuine public interest and benefit involved, but let me answer by providing the basic principle/s.

      As indicated in the post, there are four potential areas: infrastructure (PPPs to begin with), joint-ventures in mining exploration and production, industry development (including agribusiness) to boost productive capacity and clean/renewable technology.

      The guiding principle should be that projects would have to provide a solid business case with a triple bottom-line around providing social, economic and environmental benefits. They should also be in areas where the Philippines has already demonstrated a capacity in as evidenced by a clustering of businesses around a particular specialisation or where existing industrial activity can potentially spillover into a complementary or related one.

      • GabbyD

        my only question/objection is: ” that projects would have to provide a solid business case with a triple bottom-line around providing social, economic and environmental benefits” dont have funding currently?

        my gut says any industrial policy investment project is risky, and i’m not sure these are the kinds of investment that a SWF normally does.

        i mean, does any SWF anywhere do any investment in nascent industries?

        • Those objections are valid, and if it were the case, would be reasons to reject the proposal. But luckily, that isn’t what is being proposed here. The SWF would NOT be investing in specific firms. It won’t be “picking winners” as such, but would be funding industry cluster development as part of the third priority outlined above.

          These are not nascent or infant industries, but activities where the industry cluster has already been showing proven strengths (i.e. solid export performance and foreign market penetration), but for one reason or another, be it coordination externalities, information asymmetries, or path dependencies, further growth and/or value adding activities have been constrained.

          These market failures create the potential role for the state to act as a catalyst to facilitate cluster development that would allow them to achieve their full potential through a number of possible policy levers, be they government contracts, business incubators, research and development, shared infrastructure, skills formation and commercialisation of ideas.

  • UPnnGrd

    Hmmmm…. hmmmmm….. hmmmmm…. do you think OFW’s will volunteer to deposit the money they send to tgheir family/relatives in Pilipinas into a government-run SFW? That is good! Then Pilipinas can put a 7% tax on money as it changes hands.

    Maybe next is be a Malakanyang EO to “strong-arm”-encourage OFW’s to fund the SFW.

    Or maybe it becomes a declaration… the OFW remittances is “pera ng bayan”. Then and only then can Gobyerno make plans on how to spend these OFW remittances, right?

    • Unnecessary!!!!! The OFWs can keep and spend their money. What we are talking about here is the foreign reserves that they generate which the government namely the Bangko Sentral keeps some of which would be transferred to a SWF.

      • UPnnGrd

        Wow!!! So it is true, then, that Pilipinas lawmakers of previous administrations were the bestest and brightest in not applying income tax on the 10% of their population who earn salaries/wages in dollars and euros and yens. Who needs the tax when the tax is not needed to provide octane to Pilipinas projects…. hooray Pilipinas!!!!

        By the way….. how much in millions-of-US-dollars per year are we talking about, this “portion of foreign reserves from OFW remittances” which the Bangko Sentral can keep?

        • It would only be counter-productive to impose a surcharge on foreign remittances (which is essentially a transactions fee) as informal rather than formal channels will be used to send money home. I would prefer that hard currencies pass through our banking system. Our policymakers will have a better handle on it if it does. I would rather place a tax on the money that is used for consumption or property, not saved or invested, which is essentially what is in place right now.

  • Angelita Coronel

    It would be safe to act now at developing our other natural resources and not sell them out of the country. We could start putting up windmills in every farmland to provide electricity and water system to aid farmers produce more for self sufficiency and not to rely on Imports for prime necessities. Provide them with housing projects using local building materials and showcasing our rich culture, arts and heritage, attracting foreign tourists to have more fun spending their money in the Philippines!!!! Let’s invest in our country now to prepare for the homecoming of our heroes from all over the world to enjoy their hard earned wealth in our country instead of touring to other places!!! It’s about time!!!

    • Wouldn’t it be wonderful, Angelita if we could use wave energy out at sea to power our coastal communities and remote islands? Then the same weather patterns that create challenges for our country would be harnessed to provide for its development and jobs for our engineering and maritime graduates.

  • What a wonderfully refreshing blog, looking for solutions rather than problems. I hope you will fire this off to the Philippine financial gurus. OFW’s are the “oil” of the Philippines. The trick is to take short-term revenue gains and translate them into long term benefit, as your proposal does. Nice work.