The Asian crisis was one of the busts in boom-bust cycles in a span of 3 decades: 1984-85, 91-93, 98-99, 2001. These busts made Phil. a laggard in East Asia
Growth Rates Before and Asian Crisis. Looks like return to pre-1998 growth rates from 2002 to 1 st Q of 2007. Continuing rise of overseas workers remittances 199519961997199819992000200120022003200420052006 20071 Q GDP Growth4.685.855.19-0.583.405.971.764.454.936.184.975.376.91 GNP Growth4.8126.96.36.1993.737.072.264.185.956.725.646.216.64 NFIA, % of GDP2.7188.8.131.52.576.677.206.927.968.519.1910.079.27
But there are problems: - The growth rates may be overestimated. - The quality of the growth is marred by: - There are lower investment rates, as they are replaced by lower trade gaps, and the lead growth sector on the demand side is consumption. Productive capacity in the future is jeopardized. - The growth rates occur as both savings and investment rates (as % of GDP) are falling - It follows the previous growth path of a very low manufacturing and industrial base, and the current growth is spurred by services.
The latest high growth rates in 2002-2006 marred by exceedingly high and positive statistical discrepancy, which makes one suspect the supply side data are overestimated. Base year of constant prices is 1985, where the relative prices no longer hold.
Clear continuing decline in the share of investment after Asian crisis. Consumption share increases with each recession. Current growth spurred by consumption and declining trade deficits.
There was large investment-savings gap (representing trade deficits) before crisis. This gap was reduced after the crisis as investment share fell, even as gross domestic savings as share of GDP also fell. Declining savings and investment rates!
Economic Collapse in Mid-80s brought industry and manufacturing shares down and these have remained stagnant. As agriculture share falls, main growth comes from services
High inflation rates occur during recessions because of the massive devaluation. The pass-thru effect had lessened in the Asian crisis and further depreciation
The Philippines Usually Enters a Crisis When International Reserves Fall Below Two Months of Imports
Until the Asian Crisis, High Growth Leads to Current Account Deficits, Recessions Preceded by High Current Account Deficits, Recessions Accompanied by Devaluations and Improvements in Current Account Deficits
Balance of Payments, % of GDP 19961997199819992000200120022003200420052006 CURRENT ACCOUNT -4.8-5.32.4-3.8-2.9-2.4-0.40.41.92.04.3 Goods and Services -9.4-12.3-4.1-10.0-10.3-12.0-9.8 -8.6-9.3-6.5 Goods 1/ -13.7-13.50.0-7.8-7.9-8.8-7.2-7.3-6.6-7.9-5.9 Net Services 4.21.2-4.0-2.1-2.5-3.2-2.6-2.5-2.0-1.4-0.6 Net Income and Current Transfers 4.77.06.56.184.108.40.2060.210.511.310.8 CAPITAL AND FINANCIAL ACCOUNT 10.01.5-0.48.72.31.50.6-0.5-2.20.4-1.8 Net Financial Account 220.127.116.11.54.30.5 0.6-1.92.2-1.6 Net Direct Investment 18.104.22.168.22.214.171.124.126.96.36.199 Net Portfolio Investment 6.40.7-1.44.8-0.70.11.00.7-0.73.52.3 Net Financial Derivatives 0.0 0.10.0 -0.10.0 -0.1 Net Other Investments 5.65.9-1.1-0.82.10.0-2.3-0.3-1.4-3.0-5.7 Net Errors and Omissions -3.6-6.4-1.23.0-188.8.131.52-1.1-0.3-1.8-0.3 OVERALL BOP POSITION 5.2-3.82.04.9-0.60.2-0.1-0.32.42.5
Volatilities in the External Account. Capital Account volatile due to capital account liberalization The recent growth period is still accompanied by trade deficits but no longer current account deficits because of the exploding remittances of overseas workers High portfolio and other investments in 1996 (pre-crisis), fall in 1997 and 1998, fleeting and partial return in 1999 and 2000, net outflows in 2001 to 2004 because of political instabilities and fiscal crisis, return of direct and portfolio investments in 2005 and 2006, but increased outflows from residents in other investments in 2005 and 2006.
Capital Account Liberalization Starting in the 1980s Has Resulted in Volatilities in Exchange Rate
Recent Strong Appreciation of Peso Worries Exporters and Overseas Filipino Workers Strong appreciation of the peso in 2005 up to present due to global weakness of the dollar and strong remittances of Filipino workers (plus some portfolio inflows as fiscal crisis waned) Worries exporters and import- competing domestic sectors Reduces purchasing power of the overseas Filipino workers
Loss of Confidence in Financial System Continues
Low Financial Confidence: Declining M2 and Domestic Credit as % of GDP After Asian Crisis
Weak financial confidence: Banks dont want to lend to private sector because of: Strict capital adequacy ratios, loan-loss provisions, Strict view of having to quickly dispose of non- performing assets Financial institutions prefer government securities – had kept interest rates low despite fiscal crisis Political instabilities Fiscal crisis (and other economic instabilities – high oil prices included)
Ingredients of Another Asian Crisis Philippine Style in the Making The volatile external sector, the strong appreciation of the peso Banks not lending to private sector Recent rise in bank lending in early 2007 mostly to real property (possible property bubble) Even as bank lending recovered in 2007, the Central Bank instituted mopping up liquidity due to high inflows of remittances due to the inflation targeting policy Stock market increasing by almost 100% between 2004 and present (speculative bubble) Growing portfolio inflows especially to the stock market Only missing ingredient is current account deficits but Phil international reserves much smaller than other countries
Extreme burden of public debt service, high public debt burden As % of NG Revenues: NG Debt Service Payments35.642.944.348.461.973.585.183.287.2 Interest21.622.227.430.832.135.436.936.731.7 Principal14.020.716.917.629.8184.108.40.2065.6 As % of GDP As of July 2006** Total National Gov't Debt56.159.664.665.771.078.279.072.369.6 Domestic31.932.931.834.437.139.741.540.238.2 Foreign24.226.832.731.333.938.537.532.031.4 As % of GDP Total Public Sector Debt94.6101.5108.0106.0110.2118.2109.893.4n.a. Domestic35.232.832.132.734.435.735.433.0n.a. Foreign59.568.775.973.375.982.574.460.4n.a.
But fiscal crisis continues despite improvements in 2006 S & P and Moodys refused to upgrade Phil sovereign credit rating in 2007 Increase in 2006 tax effort due to implementation of expanded VAT (very popular with big business, very unpopular with the people) Expanded coverage of VAT to include services Increased VAT rates from 10% to 12%
But fiscal crisis continues despite improvements in 2006 Tax effort fell to 11.6% in first quarter of 2007 despite economy growing at 6.9%. Revenue collection and budget deficit targets from Jan to May 2007 missed. IMF, credit rating agencies and international financial sector demanding new tax measures. Government officially resisting because of defeat in senatorial elections Govt realizes need to increase tax administration of the big corporations and rich, but political will (??). Bureau of Internal Revenue head sacked in June 21, 2007. Govt plans to sell and privatize government assets and companies to make up for missed targets Govt has promised massive infrastructure building – now may no longer be feasible (effect on business confidence?) Fiscal targets very strict -- trying to reach fiscal balance in 2008. Shooting oneself in the foot. Inability to achieve target fiscal balance causing loss in confidence
Persistent High Unemployment in 2000-present: High Labor Force Entry, Low Absorption in Agriculture & Industry
Increasing Labor Productivity in Agriculture and Industry at the Back of High Unemployment: Labor Cost-Cutting Is Coping Mechanism to Trade Lib and Adverse Macro Conditions
Unemployment rate was supposed to have fallen significantly in the first quarter of 2007 when GDP growth was 6.9%. But is this sustainable?? (Recall missed targets on tax revenue and budget deficit, jeopardizing pump-priming and infrastructure building)
Recipe for Another Crisis? It is clear that the refusal to address the root causes of the Asian crisis and the faithful implementation of the standard Washington Consensus policies - very strict fiscal targets - capital account liberalization - floating exchange rate regime - full trade lib and deregulation - monetarist policy to inflation (inflation targeting) are laying the ground for another potential financial crisis.
Undervalued Currency With Market-Based Capital Controls on Inflows Establish Peso narrow band at undervalued level (by more interventions in current appreciation trend) Supported by Chilean tax on short-term capital inflows, or exit tax for capital outflows on funds less than one year (Malaysian style) -To reduce exaggerated short-term capital inflows and outflows -To ensure more exchange rate and price stability -To protect export and import-competing sectors -To protect purchasing power of overseas workers -Policy will bias monetary policy to more accommodating rather than contractionary stance -May still need to manage possible sudden sharp pressures for currency depreciation and capital outflows due to fiscal problems and political instabilities, but more manageable if currency is already undervalued.
Relax Overly Strict Fiscal Targets and Implement Progressive Taxation Instead of imposing indirect taxes and targeting taxation of fixed income earners, the government should improve tax administration and remove the high exemptions for corporations and rich individuals Fiscal deficit targets should allow for 2% to 3% of GDP, which are not at dangerous levels The current high public debt service burden should be reduced by strong negotiations for debt and interest reduction, and if not possible, at least long-run rescheduling at lower interest rates to reflect current international lending rates
Industrial Policy: Market Failures vs. Govt Failures Despite free trade policies, the government is actually promoting call centers and business process outsourcing (BPO). The high growth in services involve this sector plus financial sector and the informal low- productivity services. BPO has little multiplier effect. It is recommended that promotion also be undertaken for viable sectors with more multiplier effect, higher technological spillover, employment generation and high economies of scale, via providing complementary infrastructure, direct or credit subsidies, tax incentives for such sectors (e.g. backward linkaging of semi- conductors) This requires an efficient and honest government that undertakes these processes with transparency, fairness and correct incentives. Political struggle needed.
Reducing Restrictive Inflation Targeting and Financial Liberalization Policies Monetary and credit policies should be supportive of the integrated industrial policy, so that liquidity in the system will not be wasted in speculative activities (too much investments in high-end real property and the stock market) Instead of mopping up liquidity for fear of inflation or over-speculation, the low lending to the private sector should be corrected by redirecting liquidity to lending of priority sectors through proper economic and credit incentives.
A More Pro-Growth Monetary Policy Rediscount windows of Central Bank may become more active in credit allocation to banks with loan portfolios that are more productivity and employment-sensitive with healthy repayment rates. (Targeted credit is uphill fight in the Philippines) If oil price and world interest rate increases abate, possible consideration of some monetizing of fiscal deficits to ease the fiscal problems (this is also an uphill fight for the Philippines) and stop constriction of fiscal spending