Tempests Threaten the Philippines and the Peso in Power Game 217.0

In Q1, the Arroyo administration spent P400 billion from borrowed funds mainly for infrastructure to buy Administration support for the elections. This has resulted into a blip of a growth surge to 7.3% for the quarter but leaves an egg for a huge budget deficit for the incoming Aquino administration for the rest of 2010.

Hard challenges face the new Aquino administration to bring a possibly runaway public deficit under control while at the same time funding development.

These conflicting goals must be achieved in balance while managing expectations from campaign promises that, even now, the Arroyo administration seems to be already engineering to fail beyond her term via midnight appointments and over-borrowing, and in the context of the opposition leadership she expects to get as Congressperson beyond June 30.

(The lede above updated today, 5/31/10. National income statistics only capture data from 60% of the total economy thus initial 0.4% attribution to election spending. Most election spending probably reflected at first in 40% underground economy though eventually affecting in the formal economy.)

If the deficit is not placed under control, the Philippines can go into the bust segment of the boom and bust cycle that has been the country’s fate for long.

This boom and bust cycle, that is typically accompanied by inflation and peso devaluation, is one reason that Filipinos do not engage in higher risk-return investments like technological innovation and instead take more to hedged ones like real estate development.

Ring of Fire. PIMCO Bill Gross’s ring of fire is the global finance context of this problem.

Diagram credit & link to PIMCO article: The Ring of Fire, Bill Gross, PIMCO Investment Outlook, Feb 2010.

It is a graph between the public sector debt and public sector deficit (both expressed as % of GDP).

As can be noted from the diagram, Greece and the rest of the PIGS – Portugal, Italy and Spain in Europe – that have sovereign debt problems are in this ring of fire.

The Philippines, with 62.3% of public debt and 3.74% of public deficit (2009 data as of February 2010), is just northwest of this ring of fire. Our level of public debt is 50% higher than is the typical of 40% of emerging markets.

Short-Term Forecast.In today’s Inquirer, Finance Secretary Teves of the outgoing Arroyo administration thinks that in 2010 the debt level will improve to 3.3% but, without new revenue measures, the public debt position will worsen to 4.4%.

He does not sound confident about President-presumptive Aquino’s revenue plan that focus on cutting corruption and tax collection improvements. Secretary Teves urges a Plan B, in the Inquirer article today (Click image for link to Inquirer), that includes raising VAT to 15% from the current 12%.

Note that we considered the increase of VAT to 15% in a previous poll closed in our post, SYNTHESiST Surveys on Philippine Financial Problems on February 10, 2010. The respondents were not enthusiastic about this option, to say the least.

Out of the four options, the respondents support President-presumptive Aquino’s plan of improved tax collection efforts.

The Fate of the Innovator Peso. Still, if the new Aquino administration presents a weak economic team or, subsequently, shows itself unable to bridge the budget gap by its plan, either by raising tax revenues or by controlling expenditures, the peso’s value will depreciate as investors and funders stay away.

Elsewhere in SYNTHESiST, in a three-part post on the Bangko Sentral in May 24, 2009, I posited that an innovator Peso that has a stable value is a pre-condition for indigenous innovation – and self-sustaining development – to flourish in any country. This implies that a firm foundation to progress if we get our monetary and fiscal house in order.

Limits to sovereign debt financing. In their well-written book, This Time is Different, economist-authors Carmen Reinhart and Kenneth Rogoff indicate that 60% of GDP as level of public debt is a danger signal (though first-tier developed countries like Japan and the United States have done well at much higher levels).

Note: Bill Gross of PIMCO, in the article I linked to above, acknowledges the influence of this book in writing his Ring of Fire article in February, 2010.

Like successful companies with huge cash flows from profits, countries with higher value added can also load up their balance sheet with debt without major issues.

The problem in the Philippines is that we do not have that cash flow, i.e. from tax revenues and value-added, to support a much higher debt level from foreign funder.

Even local retail bonds – the only ones we seem to be able to raise – have to be denominated in US$ to be attractive to investors.

Crises as White Swans. Nouriel Roubini, who correctly predicted the 2007 financial crises, writes in this book that crises are normal, rather than long-tail events, in a capitalist environment. He shows in this book how he was able to make the correct predictions so we may also be able to avoid a repeat of the crises.

Still I catch a hint that he blames the success of the Great Moderation of the 1990s, when the Central Bankers of the world seem to have avoided big crises, for the severity of the latest one.

Avoiding Boom and Bust in the Philippines. The economic crises and the Philippines are exacerbated by the political crises that occur either as cause or effect of the other thereby amplifying or minimizing the gyrations – as with radio waves – when the timing is pro- or counter-cyclical. Remittances from OFWs have tended to dampen the extreme amplifications, too.

As I have noted elsewhere in SYNTHESiST, the OFW strategy is weak for the country, even as it helps individual citizens, as it also has the unintended consequence of weakening the domestic productive sectors as the incoming dollars, sourced elsewhere, artificially prop up the economy.

A strong economy, and a truly wealthy country, can only be made with high local-value added and sustained with indigenous innovation.

The Philippines must undertake a strategy of orderly slow down and eventual repatriation i a way that makes economic sense for overseas Filipinos, too. The ideal situation is for the situation to be so improved that they bring back their savings as investment in the country.

We must strengthen institutions to be the foundation of such self-sustaining growth and perpetually dampen boom and bust cycles in the Philippines.


Updated March 14, 2011: Please extend SYNTHESiST Reach by clicking ‘Like’ on its Facebook page.


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  1. [...] his latest book (2010 Harper) at right, he echoes economists like Nouriel Roubini, and Carmen Reinhart and Kenneth Rogoff in saying that regular crises are the normal but expected [...]

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