Upgrading Growth and Upping the Ante on Reform
Daniel Lian (Singapore)
Upgrading 2004 Growth to 5.6%
The Philippine economy has performed better than we expected in the first half of this year. After a 6.5% year-on-year expansion in 1Q04, it grew a further 6.2%, bringing first-half expansion to 6.3%. This is considerably better than the 4.7% growth rate achieved in 2003. The key driver of growth remains private consumption—it represented three-quarters of growth in 1H04 as household spending was buoyed by a pickup in export earnings and overseas workers’ remittances as well as election spending—but both investment and exports are also helping growth. Despite our belief that the economic deceleration is already well under way in the third quarter, we are raising our full-year 2004 GDP growth forecast from 4.5% to 5.6%, anticipating a second-half growth rate of only 4.9%.
Upping the Ante on Reform
We have consistently viewed President Gloria Arroyo and her administration as a pro-restructuring government (Still No Magic, August 27, 2002). However, reform has proved to be extremely difficult to implement by Ms. Arroyo. This is perhaps due to the fact that her ascent to the Presidency in January 2001 was without a direct electoral mandate. In consequence, it has become difficult for her administration to institute administrative reform against oligarchies such as the Catholic Church, landlords, and big business interests. Despite a fresh mandate, her razor-thin margin of victory and a continued deterioration in the fiscal environment mean Ms. Arroyo must deliver effective reform in time to dispel doubts about her legitimacy and win the confidence and support of the nation. We are thus not surprised that Ms. Arroyo is upping the ante on reform. A recent report by economists at the University of the Philippines said the country faces economic collapse in two to three years unless the government curbs its deficit spending and reduces debt by adopting a package of revenue- and cost-saving measures. In response to the report, the President issued an alert on August 23 that the Republic is in the midst of a fiscal crisis and urged the people to be prepared to make sacrifices for the good of the nation. In our view, Ms Arroyo’s comments about the precarious state of public finances are clearly designed to help mobilize support for her planned tax increases, a critical first step of her reform.
Strengthening Fiscal Sector the Critical First Step
Putting strengthening of the fiscal sector at the top of the policy agenda is indeed the right move for Ms. Arroyo, in our opinion. The Philippines’ number one structural economic malaise remains its weak fiscal sector. The financially strapped government has caused a significant drag on the country’s saving rate, which, in turn, has slowed capital formation and economic growth. 1) Large budget deficit and rapidly rising public debt—The Philippines has had chronic budget deficits since the 1970s, and since 2000 it has been running budget deficits exceeding 4% of GDP. Outstanding national government debt rose from 65% of GDP in 2000 to some 78% in 2003. By contrast, the two more heavily indebted economies in Southeast Asia—Thailand and Indonesia—experienced balanced budgets and substantial decline in public debt and debt service ratios. 2) Fiscal weakness is structural in nature—Not only is public debt rising rapidly, but the Republic’s fiscal weakness appears to be structural in nature. The rising deficit is used to finance government consumption rather than investment, and more than one-third of government spending is eaten up as interest payments on debt. The tax collection effort ratio (as % of GNP) has declined from an average of 15.6% during the Fidel Ramos era (1992-98) to an average of only 12%. In consequence, government debt as a percentage of revenues now exceeds 500%, substantially more than the country’s indebted Asian peers.
Other Critical Areas of Reform
While fiscal reform is the critical first step, the structural impediments confronting the Republic stretch beyond mere government finances. In our view, Ms Arroyo must engineer an economic strategy and overcome the institutionalized rent-seeking complex that permeates Philippine society. 1) Rural development platform and long-term economic development strategy: We believe the Philippines has few prospects for winning the global FDI game in the near future. The low-value generic mass manufacturing-based export model will not bring sufficient economic growth and the prosperity that are desperately needed to circumvent low growth, high debt, and poverty traps. It is thus critical for policymakers to establish a well thought out rural development platform to better leverage the country’s vast but underprivileged and less developed rural sector—the Philippines’ rural population is 41%. The Republic also needs to map out a long-term development blueprint with a strengthened platform to address the long-term development needs of the urban poor, resources, SMEs, and the government and corporate sectors. In our view, Thailand’s dual-track development strategy has a lot of relevance for a predominantly agrarian-based economy that has experienced only skin-deep industrialization like the Philippines. We believe the Thai dual-track strategy should be emulated based on the Republic’s needs and local conditions. 2) Ineffective government institutions vs. an institutionalized rent-seeking complex: In the Philippines, public institutions are not strong, and there is a well-entrenched rent-seeking complex that dominates the corporate-economic-social-government spheres. The rent-seeking complex is so “powerful” that a substantial part of any economic benefits is appropriated by a few—the oligarchies—leaving most of the population without much economic or social mobility. 3) Capital and intellectual capital flight: A substantial stock of domestic saving resides overseas, and the top echelons of talent are not serving the domestic economy and institutions.
Daniel Lian (Singapore)
Upgrading 2004 Growth to 5.6%
The Philippine economy has performed better than we expected in the first half of this year. After a 6.5% year-on-year expansion in 1Q04, it grew a further 6.2%, bringing first-half expansion to 6.3%. This is considerably better than the 4.7% growth rate achieved in 2003. The key driver of growth remains private consumption—it represented three-quarters of growth in 1H04 as household spending was buoyed by a pickup in export earnings and overseas workers’ remittances as well as election spending—but both investment and exports are also helping growth. Despite our belief that the economic deceleration is already well under way in the third quarter, we are raising our full-year 2004 GDP growth forecast from 4.5% to 5.6%, anticipating a second-half growth rate of only 4.9%.
Upping the Ante on Reform
We have consistently viewed President Gloria Arroyo and her administration as a pro-restructuring government (Still No Magic, August 27, 2002). However, reform has proved to be extremely difficult to implement by Ms. Arroyo. This is perhaps due to the fact that her ascent to the Presidency in January 2001 was without a direct electoral mandate. In consequence, it has become difficult for her administration to institute administrative reform against oligarchies such as the Catholic Church, landlords, and big business interests. Despite a fresh mandate, her razor-thin margin of victory and a continued deterioration in the fiscal environment mean Ms. Arroyo must deliver effective reform in time to dispel doubts about her legitimacy and win the confidence and support of the nation. We are thus not surprised that Ms. Arroyo is upping the ante on reform. A recent report by economists at the University of the Philippines said the country faces economic collapse in two to three years unless the government curbs its deficit spending and reduces debt by adopting a package of revenue- and cost-saving measures. In response to the report, the President issued an alert on August 23 that the Republic is in the midst of a fiscal crisis and urged the people to be prepared to make sacrifices for the good of the nation. In our view, Ms Arroyo’s comments about the precarious state of public finances are clearly designed to help mobilize support for her planned tax increases, a critical first step of her reform.
Strengthening Fiscal Sector the Critical First Step
Putting strengthening of the fiscal sector at the top of the policy agenda is indeed the right move for Ms. Arroyo, in our opinion. The Philippines’ number one structural economic malaise remains its weak fiscal sector. The financially strapped government has caused a significant drag on the country’s saving rate, which, in turn, has slowed capital formation and economic growth. 1) Large budget deficit and rapidly rising public debt—The Philippines has had chronic budget deficits since the 1970s, and since 2000 it has been running budget deficits exceeding 4% of GDP. Outstanding national government debt rose from 65% of GDP in 2000 to some 78% in 2003. By contrast, the two more heavily indebted economies in Southeast Asia—Thailand and Indonesia—experienced balanced budgets and substantial decline in public debt and debt service ratios. 2) Fiscal weakness is structural in nature—Not only is public debt rising rapidly, but the Republic’s fiscal weakness appears to be structural in nature. The rising deficit is used to finance government consumption rather than investment, and more than one-third of government spending is eaten up as interest payments on debt. The tax collection effort ratio (as % of GNP) has declined from an average of 15.6% during the Fidel Ramos era (1992-98) to an average of only 12%. In consequence, government debt as a percentage of revenues now exceeds 500%, substantially more than the country’s indebted Asian peers.
Other Critical Areas of Reform
While fiscal reform is the critical first step, the structural impediments confronting the Republic stretch beyond mere government finances. In our view, Ms Arroyo must engineer an economic strategy and overcome the institutionalized rent-seeking complex that permeates Philippine society. 1) Rural development platform and long-term economic development strategy: We believe the Philippines has few prospects for winning the global FDI game in the near future. The low-value generic mass manufacturing-based export model will not bring sufficient economic growth and the prosperity that are desperately needed to circumvent low growth, high debt, and poverty traps. It is thus critical for policymakers to establish a well thought out rural development platform to better leverage the country’s vast but underprivileged and less developed rural sector—the Philippines’ rural population is 41%. The Republic also needs to map out a long-term development blueprint with a strengthened platform to address the long-term development needs of the urban poor, resources, SMEs, and the government and corporate sectors. In our view, Thailand’s dual-track development strategy has a lot of relevance for a predominantly agrarian-based economy that has experienced only skin-deep industrialization like the Philippines. We believe the Thai dual-track strategy should be emulated based on the Republic’s needs and local conditions. 2) Ineffective government institutions vs. an institutionalized rent-seeking complex: In the Philippines, public institutions are not strong, and there is a well-entrenched rent-seeking complex that dominates the corporate-economic-social-government spheres. The rent-seeking complex is so “powerful” that a substantial part of any economic benefits is appropriated by a few—the oligarchies—leaving most of the population without much economic or social mobility. 3) Capital and intellectual capital flight: A substantial stock of domestic saving resides overseas, and the top echelons of talent are not serving the domestic economy and institutions.
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