Bangko Sentral ng Pilipinas

Sovereign wealth fund under consideration

That was the banner story of today’s BusinessWorld online.

Here is a direct quote from the article:

Economic managers are studying the possibility of setting up a Philippine sovereign wealth fund to maximize returns from the country’s foreign exchange holdings.
“As I understand, the national government is conducting a study on the possible operations of a sovereign wealth fund,” central bank Governor Amando M. Tetangco, Jr. said at the sidelines of yesterday’s Philippine Investment Forum.

Finance Secretary Cesar V. Purisima confirmed that the plan was being considered, although he said the review remained in the preliminary stages.

“We haven’t brought up the matter with [President Benigno S. C. Aquino III] yet. So far, it’s just look, see, study and evaluate,” Mr. Purisima said.

As readers of this space will be aware, I have been harping on this issue for over two years now. Before anyone in the upper echelons of policy making, whether fiscal or monetary, or within academia were even contemplating it, I had flagged the possibility here. The following is a compilation of the previous articles I have posted on the issue
Early this year, I developed a policy paper on this topic, which I enclose below

Fruits of Our Labour by Doy Santos

It’s good to see that after more than two years of writing and engaging with the issue, the idea is finally being seriously considered by both the Department of Finance and the Bangko Sentral as confirmed by today’s news item . Even more surprising is how prominent economists are now supporting the principle of establishing a sovereign wealth fund for the Philippines. If this should be included among the administration’s priority bills for the 16th Congress, it would be timely as the country is expected to receive investment grade status by the end of the year.

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.

Spend More, Talk Less

With the release of third quarter GDP figures upsetting all but the most ardent economic apologists for this administration, the time has come for it to re-think its priorities.

image from wallpapers-diq.net

The situation is nearing a critical level. As the whole of Europe is placed on credit watch and as recovery in the US struggles for momentum, the vibrancy in the domestic economy is being sucked out by government’s poor infrastructure spending rate just at a time when it is needed. Cabinet officials throughout the year have been promising a more rapid deployment, but this has so far not materialized.

The incorrigible ‘prophet of boom’ from the Ateneo Graduate School of Business Cielito Habito despite his best efforts at painting a rosy picture for the government has himself acknowledged the third quarter results to be disappointing. Here is how this professor of ‘Aquinomics’ concludes his most recent column for the Inquirer entitled, Is confidence dissipating?

(W)hat worries me most is the possible dissipation of the initial confidence surge that greeted the new administration and led to brisk private domestic investment growth over the past year. With these private domestic investment numbers now apparently slowing down while price increases have been speeding up, the President and his men on top of the economy should keep a close eye on the ball—or risk losing steam altogether (emphasis added).

That’s it—the penny has finally dropped. Only a delusional person would keep insisting that the government is headed in the right direction when it comes to managing the economy. Will this lead to a teachable moment, or will the administration remain antagonized by criticism seeing sinister plots behind them, spooked by shadows and haunted by the spectre of its immediate predecessor?

Throughout the year, the government has continued to fall back on its good poll figures to demonstrate that it has been performing to the satisfaction of the people. Poll figures however may not be a good barometer of the government’s competence in economic affairs given the ‘halo effect’ that has made the administration appear more creditable than it should.

Market analysts have already pointed out and the Bangko Sentral agrees that stimulating greater demand to address the slowdown in growth lies not in the hands of monetary authorities at this point but with fiscal managers. What this means is that the government has to spend more and talk less. Or in the words of Jerry Maguire, it has to “show me the money!

All talk, no action

The government talks profusely about the need to ramp up infrastructure spending in its Philippine Development Plan released early this year (see page 17). “An inefficient transport network and unreliable power supply”  is what has created a poor investment climate according to the Plan. Solving this meant greater spending, but when it comes to actually delivering on this, the government fell short of its rhetoric. Next year’s appropriations will hit a mere 2.5%, when the benchmark for a middle income country such as ours is 5% of GDP.

P-Noy in his first SONA said that the infrastructure build-up would be achieved through public-private partnerships, but nearly eighteen months on and counting, the fulfillment of the now diminished scope of this program remains to be seen. The confidence of the business community will eventually wear thin as Habito suggests if delays persist.

When the president addressed a meeting of the Makati Business Club, a community highly supportive of his candidacy, there was some disappointment over his over-emphasis on the case against former president Gloria Arroyo and his squabble with the Supreme Court. As these businessmen suggest, the risk is for P-Noy to get so focused on prosecuting Mrs Arroyo that he fails to keep his ‘eye on the ball’.

And it requires some doing. To ramp up spending by 2.5% of GDP will require as much concentration as he can muster. In a ten trillion peso economy, this will mean doubling the present effort of 250 billion pesos a year. This will dwarf  the growth of the CCT or conditional cash transfers which cost about thirty billion.

Because the president closed off the avenue of raising revenues through new taxes, he found himself left with no other option but to fund his development plan through private financing. That has proven tricky as well, which is why he now needs to consider a third option.

That third option which I had first written about late last year which then got echoed by no less than the BSP Governor a few months back is for the government to issue infrastructure bonds to the BSP which is at present earning negative returns on its foreign currency reserves.

Better returns

By offering the Bank a better yield, the government would be doing it a favour. Raul Fabella a former dean of the UP School of Economics has lent this proposal his seal of approval. He believes the risk from runaway inflation to be negligible under the proven monetary stewardship of the BSP.

The continued growth of foreign remittances from OFWs makes this option feasible, but if the government needed further convincing, then the following points should help build the case for it:

  1. Infrastructure spending is needed as we face a slowdown of demand from Western economies for our goods and services.
  2. It is the best vehicle for avoiding the ‘Dutch disease’ that afflicts countries experiencing windfall profits from resource booms (in our case, this stems from human not natural resources).
  3. Unlike increased social entitlement spending during a boom which becomes painful to retract at the end of the cycle, infrastructure spending leaves a tangible legacy and productivity dividend.
  4. It will help our exporters remain competitive because the increased spending will lead to a modest rise in inflation which will stem the appreciation of the peso against the greenback.
  5. It will unlock complementary investments by the private sector which is being deterred by poor public infrastructure.
  6. Government failure will be minimized as most transport and power projects can be turned over to the private sector under a PPP arrangement once completed. Revenue earned from transport and power projects would settle the interest and debt owed to the BSP.
  7. It will help prop up employment and growth which will spur increased tax collection.
  8. It will reduce the cost of doing business for most firms, not just exporters.
  9. It will help achieve the government’s growth target of 5-7% in the medium term.
  10. It will fulfill the government’s own development plan and set us on a higher growth plane.

Greater public infrastructure spending not by new taxes, nor by increased external or internal borrowing (as per Mrs Arroyo’s stimulus program in 2008/09), but by tapping our excess foreign currency reserves is not only appropriate, it would be the most effective and innovative way for this government to sustain economic growth through the turbulence in the global economy and beyond.

But we have to get real now. When faced with a possible course of action that is within the feasible set as defined by technocrats, what often prevents governments from acting is not the lack of rational arguments but the incentive problem. What led to this whole debacle in the first place was the administration’s fear of spending that would benefit internal patron-client networks left behind by its predecessor. In other words, politics rather than economics has been driving its decisions.

Making daang matuwid work

In the past we have seen how corruption and rent-seeking have reduced the amount of money available for developmental spending, but now we see how the opposite has reduced that amount even more. In the words of Samuel Huntington, “In terms of economic growth, the only thing worse than a society with a rigid overcentralized, dishonest bureaucracy is one with a rigid, overcentralized honest bureaucracy.”

The challenge for P-Noy is to make his mantra of daang matuwid work for the country rather than against it. Through the discipline and hard work of Filipinos working overseas, the country has a rather unique opportunity to make up for the shortfall in taxes generated internally. The current situation reminds me of the parable of the talents where the honest, but slothful servant dug a hole in the ground to store the talent that was entrusted to him by his master for safekeeping.

The Aquino government is like that servant. It was entrusted with a small but buoyant economy at the beginning of its term. So far, it has managed to keep it afloat, running while standing still, growing on aggregate but shrinking in real per capita terms. At the end of the story, the master reprimands the servant by saying, “To everyone who has will be given, and he will have abundance, but from him who doesn’t have, even that which he has will be taken away.”

That sound a lot like where the economy is heading under the president’s watch. The little that the Philippines had at the start could be taken away from it, while the plenty that our ASEAN neighbours have keeps on growing. It is time this government put its money where its fiscal mouth has been and start showing us the money. From another biblical parable comes the saying, “to whom much is given, much is required.” P-Noy was given a huge electoral mandate back in 2010. It is time he used it.

At last, some sen$e!

Monetary officials have finally learnt how to deal with the rising peso–something I have been advocating they do since late last year.

When I flagged the problem of an appreciating peso back in November 2010 (see What Should be Done About the Rising Peso?) and suggested some ideas on how to remedy the situation (setting up a sovereign wealth fund), I was met with more than a little bit of skepticism by readers. At that time, our foreign reserves climbed to $44 billion from $33 billion a mere eighteen months earlier.

In January this year, I pointed out the strategies of similarly situated Latin American central banks and finance ministries (see What Should be Done with a $14.4 billion BoP Surplus?). My advocacy for us to turn to methods outside the traditional toolkit of monetary policy seemed far-fetched as Bangko Sentral officials then were expressing satisfaction with the effectiveness of their interventions in the currency market. Again, my ideas were met with a bit of scorn by some readers.

And then in July this year, when our gross international reserves for the first time exceeded our external debt obligations, I made the following policy pitch in Crediting the Upgrade:

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.

I had honed the idea from suggesting a sovereign wealth fund that would look at investment opportunities both domestic and overseas to more inward directed investment opportunities. The channel through which the fund would be created was to be through the BSP purchasing sovereign debt issued by the National Government (in effect becoming a creditor of the government). This would reduce our need to borrow from abroad, which would lower the pressure on the peso to appreciate.

With this last pitch, I thought I had a winner, although not much in terms of reader response occurred. Also, as the storm clouds seemed to gather on the horizon, I found the BSP’s response to be similar to the government’s–a wait and see strategy, which I felt needed to be more pro-active (see Bullet-proofing the Economy and A Full-Blown Economic Storm). The government was still banking on its credit upgrade and private partnerships to save the day.

The policy space just seemed sterile with worn out mantras and textbook formulas. Then today, I gained some level of comfort in discovering that our officials might have finally “seen the light” by reading Benjamin Diokno’s column. In it, he describes the offer made by Bangko Sentral Governor Armando Tetangco to loan the government dollars and be repaid in pesos as a “Win-win Move“!

What might have tipped the conservative monetary authorities over was the Philippines attaining its full-year gross reserves target of $75 billion in the middle of the year. Diokno highlights the precariousness of maintaining current fiscal and monetary policies by saying,

(F)or every peso appreciation, BSP stands to lose P75 billion. Isn’t that awful? Hence, Mr. Tetangco is not offering the government out of the goodness of his heart; he’s doing it because it’s the prudential thing to do. It’s a win-win solution to our economic woes: it helps BSP in its war against peso appreciation and, at the same time, it helps the government pay for its foreign debt without incurring serious foreign exchange risks….

In hindsight, it was not even necessary for the Philippine government to borrow from the World Bank and the Asian Development Bank to finance its conditional cash transfer (CCT) program. Floating five-year Treasury bonds would have been a better way of financing the program.

At last, even traditional economists are beginning to realize what a golden opportunity the Philippines was sitting on! Ah, yes! There are times when it just feels good to be right. And this is definitely one of them. Let us hope our finance officials are able to learn the “policy catch-up” game just as our monetary officials have finally learned to. It’s about time they gained some sense.

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.

Principle or politics?

The policy elite continue to give President Aquino the benefit of the doubt as a stream of bad news regarding the state of the nation hit the headlines in the last couple of weeks.

A series of indicators seemed to point to the deteriorating state of governance in the country. Despite all this, expert commentators continue to give consideration to what they see as the genuine desire of the president to steer the ship of state safely through the rough seas. In the space of a few weeks, a number of surveys uncovered a not too rosy picture of the country. In quick succession the following came up:

To the policy elites, these reports would certainly be disconcerting as the consensus has formed that the actions taken by the Palace have allowed the country to turn a corner. Take for instance the PERC survey. Ateneo economist Cielito Habito asks whether corruption is really worse, stating that the sentiment of domestic investors who possess more complete information regarding the state of affairs in the country counts more than the views of foreign players. Domestic investments have surged under the new administration. He provides a plausible reason for the worsening perception of foreign investors identifying the senate hearings on corruption in the military in the first quarter which may have tarnished the entire government’s overall reputation in the eyes of these executives.

On the fall of the president’s trust ratings, UP economist Solita Monsod countered over the weekend that a number of appointments bode well for the president’s agenda on good governance. These good appointments may be just a fluke as the underlying current that runs through them may be factional infighting among his political supporters, but never mind, she says, as a win is a win.

On the rise of hunger, sociologist Randy David poses one possibility (remote though it seems) that the self-reporting on hunger may have gone up as many of those surveyed mistook the SWS interviewers for public social workers who were reportedly screening households for the conditional cash transfers program that would entitle them to receive monthly allowances. As for the fall in consumer confidence, this was attributed to external factors stemming from the uprising in the Middle East and North Africa affecting prospects of foreign nationals working in the area.

Just a few months back, the president was claiming credit for the decline in poverty incidence saying that his reforms had already borne fruit. Never mind that what was being reported was the effect of reforms instituted by the previous administration.

Now it seems in a bid to counter the negative news, the president has been going out on the offensive running after the people close to his immediate predecessor. The impeachment of Ombudsman Merci Gutierrez has occupied much of the news of late. Her trial in the senate will no doubt hug the headlines in the weeks to come. Never mind that her term is expected to expire anyway.

When the proceeds of the sale of the confiscated property of Lt Gen Ligot was handed over to the government, the palace was quick to claim it as an endorsement of the integrity of the president. Never mind that this was the result of the actions of the lady whom they had just impeached in Congress through their party mates.

The tax fraud case filed against former presidential son Rep Mikey Arroyo is currently capturing media attention with continuing revelations of properties he is alleged to have left out in his tax declarations. While palace officials were quick to deny this move was a form of political harassment, Conrado de Quiros who many regard as a surrogate mouthpiece for the administration provided a reality check by claiming that the former presidential son was indeed targeted for this kind of treatment.

While these sorts of exposes and trials make for good political theater, allowing the administration to score political points, they do come at a cost. The cost is that the legislative agenda of the government will come to a standstill during the impeachment trial. Also there is a tendency to give the rulers a free pass on the more crucial bits of governance that go unnoticed.

Take the rise of poverty (by the proxy measure of hunger) for instance. This could have been a result of the phaseout of the grains program run by the National Food Authority. None of the policy elites want to acknowledge this because they are almost ideologically opposed to it. Yet this would explain why poverty rose in Luzon while it declined slightly in the rest of the country where the conditional cash transfers were mostly targeted.

As food inflation rises resulting from global production shortfalls exacerbated by the price of oil and transport, the timing could not be worse for the government which has withdrawn its support for the grains importation program. It is reported today that a possible rice shortage may be in the offing over the coming months.

At some point, the tendency to blame the administration immediately preceding it will become old hat. The current rulers will have to take ownership for the current state of affairs. While the policy elite might continue to give this president the benefit of the doubt, some time in the future there will be a reckoning. If the negative indicators continue to point down, that moment might come sooner than expected.

What should we do with a $14.4B BoP surplus?

The banner story in today’s business sections of the three major dailies announces the largest Balance of Payments surplus for the Philippines standing at $14.4 billion. Here is what the Inquirer reported

The sustained increase in remittances, higher export earnings and a surge in foreign capital inflows lifted the surplus in the country’s balance of payments (BOP) to an all-time high of $14.4 billion in 2010.

The Bangko Sentral ng Pilipinas on Wednesday said the BOP surplus cemented claims that 2010 was a banner year for the Philippines especially in terms of inflows of dollars and other foreign currencies.

The surplus, the highest ever recorded, was more than double the $6.42 billion registered in 2009.

For December alone, the surplus stood at $1.23 billion, up slightly from $1.22 billion in the same month of the previous year.

The BOP is a record of the commercial and financial transactions of the country with the rest of the world. A surplus, which indicates that the inflows are more than the outflows, adds to the Philippines’ total reserves of foreign currencies or the gross international reserves (GIR), which reflects the country’s ability to pay for imports and services and settle maturing debts to foreign creditors.

The central bank earlier reported that the country’s GIR registered a historic high of $62.1 billion as of the end of 2010 (emphasis added).

To put the last statement in its proper context, our current gross international reserves are enough to pay for a full year’s worth of imports! To show just how far we have come, there was a time in the mid-80s when the country struggled to even pay for a few months’ worth of imports. The forecast in 2011 is for our reserves to climb up to $70B. Because of this some have predicted that the peso could appreciate this year to 40 to a dollar. This would pose serious challenges to our export sector as well as to the workers overseas whose remittances are partly driving up our reserves.

Previously, I had commented in this space about the need for our Bangko Sentral (BSP) to start looking at new policy tools for dealing with this imminent threat. Other countries in Latin America have also been faced with rising currencies and have attempted to deal with them using both traditional and unorthodox means as the Economist has reported this week.

Having quickly shaken off the world recession, many countries in Latin America are prospering again. The region’s economies grew by an average of 6% last year, according to a preliminary estimate from the United Nations Economic Commission for Latin America and the Caribbean. This strong performance, linked in large part to the global commodity boom, has attracted big inflows of foreign cash. With that has come a familiar problem: the region’s currencies have soared in value against the dollar, making life uncomfortable for Latin American manufacturers. They find themselves priced out of export markets or struggling to compete with cheap imports. Worried governments are launching a battery of measures to try to restrain the value of their currencies.

Yet the BSP at the end of last year stated that it was quite happy with the current policy settings saying that the real effective exchange rate of the country (economistic gobbledygook for the prices of our goods that are traded abroad) have risen moderately compared to other countries in the ASEAN region. That may be cold comfort though for the families of overseas contract workers who see their expected earnings in pesos still dwindling nonetheless.

At any rate, the Philippines as always might have to play policy catch-up with its Latin American brethren (as it has with the conditional cash transfers program). Perhaps (and this is where I become a bit speculative) we ought to lend some of our reserves to Ireland or some other struggling European economy (Spain or Greece perhaps?). Expatriation of foreign reserves is not a bad thing. The country can still earn a decent return from its investments while relieving the peso from upward pressure.

Why not? If we remain timid, we might miss the boat once again. As the currency wars rage on, our response needs to be well thought through.