PHILLIPINE INSTITUTE FOR DEVELOPMENT STUDIES Surian sa mga Pag-aaral Pangkaunlaran ng Pilipinas
Vol. XXIII No. 1
January - February 2005
The
Philippine economy in 2005 Josef T. Yap*
momentum in an increasingly unfavorable global environment. Moreover, many domestic issues, particularly those related to the public sector’s fiscal problems, have yet to be satisfactorily resolved.
So, what does 2005 hold for Filipinos? As always, PIDS Senior Research Fellow Dr. Josef T. Yap provides another forecast for 2005 in this issue. He talks about the recent performance of the Philippine economy and how different sectors as well as the reforms initiated by the government in the past year could help promote—or drag down— the growth in 2005. Dr. Yap also offers recommendations to the policymakers on what to focus on this year, placing emphasis on three sets of measures that will enhance the investment environment of the country, among other things. DRN
Inside the DRN 10 Governance in Southeast Asia
ISSN 0115-9097
Forecasts, predictions...
Editor's Notes The Arroyo government has high expectations for 2005. For one, the fiscal crisis was declared over before the previous year ended. Early this year, a newspaper reports that foreign investors are "finally getting to appreciate the gains made by President Macapagal-Arroyo’s fiscal reforms," a move that made a global credit firm not consider the Philippines a credit risk. Weeks after, President Arroyo herself declares a splendid growth in the country's gross domestic product. Whether these developments can be sustained, however, remains to be seen. The main question is how these improvements can trickle down so that the common tao will benefit from them.
DEVEL O PMENT RESEARCH NEWS
P
hilippine economic performance in 2004 surpassed all forecasts. Real gross domestic product (GDP) growth last year was 6.1 percent compared to the 5.9 percent forecast published in the December 2004 Survey of Consensus Economics, Inc.1 The key question is whether the economy can sustain this
There are other reasons why GDP growth in 2005 will likely be lower. Factors that contributed significantly to the robust growth in 2004, for one, will be absent, notably heavy election spending. Meanwhile, higher taxes and persistent high fuel prices will dampen consumer expenditures. However, the
* Senior Research Fellow, Philippine Institute for Development Studies. Ms. Jennifer C. de Castro contributed to Box 1. The author would also like to acknowledge the research assistance of Ms. Merle G. Galvan. The usual disclaimer applies. 1 Consensus Economics, Inc. is a private institution that collates forecasts from about 200 economic and financial analysts from more than 70 countries. The forecasts were reported by the Asia Economic Monitor of the Asian Development Bank. The forecast in late 2003 was for a GDP growth of 4.1 percent in 2004.
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DEVELOPMENT RESEARCH NEWS
January - February 2005
Table 1. Selected macroeconomic indicators, Philippines, 1992-2004, forecasts for 2005 (annual growth rates and share to GDP, with the latter shown in italics) 1994
Gross National Product Gross Domestic Product Agriculture, Fishery and Forestry
4.6 4.4
2.6 22.75 Agriculture and fishery 3.0 21.98 Forestry -15.0 0.39 Industry Sector 5.8 34.71 Mining and quarrying -7.0 1.40 Manufacturing 5.0 24.84 Construction 8.9 5.45 Electricity, Gas and Water 13.9 3.01 Service Sector 4.2 42.93 Transport, communication and storage 4.2 5.84 Trade 4.0 15.26 Finance 5.5 4.12 Ownership of dwellings and real estate 2.9 5.54 Private services 4.3 6.94 Government services 5.5 5.24 Personal Consumption Expenditure 3.7 78.31 Government Consumption 6.1 8.13 Capital Formation 8.7 23.59 Exports (nominal $) 18.5 Imports (nominal $) 21.2 Inflation (average) 8.3 91-Day Treasury Bill Rate (average) 12.7 Nominal Exchange Rate (average) 26.4 *
1995
1996
1997
1998
4.9 4.7
7.2 5.8
5.3 5.2
0.4 -0.6
0.9 22.36 1.6 21.32 -40.1 0.22 6.7 35.38 -6.8 1.25 6.8 25.34 6.5 5.55 13.0 3.25 5.0 43.07
3.8 21.55 3.8 20.91 6.7 0.22 6.4 35.58 1.3 1.20 5.6 25.27 10.9 5.81 7.5 3.30 6.4 43.29
3.1 21.13 3.4 20.56 -30.0 0.15 6.1 35.91 1.7 1.16 4.2 25.04 16.2 6.42 4.8 3.29 5.4 43.38
5.8 5.90 5.6 15.39 7.3 4.22
7.4 5.99 5.5 15.34 13.8 4.54
3.0 5.46 4.3 6.91 3.7 5.19
1999
2000
2001
2002
2003
2004
2005 Forecast
3.7 3.4
6.9 6.0
3.5 3.0
4.5 4.4
5.6 4.7
6.1 6.1
5.4 5.6
-6.4 20.71 -6.5 19.34 3.3 0.15 -2.1 35.35 2.8 1.20 -1.1 24.91 -9.6 5.83 3.3 3.41 3.5 45.15
6.5 20.09 6.4 19.91 24.2 0.19 0.9 34.49 -8.4 1.06 1.6 24.47 -1.6 5.55 3.1 3.40 4.0 45.42
4.3 19.78 4.6 19.64 -19.5 0.14 9.0 35.46 11.3 1.11 5.6 24.39 26.3 6.62 4.2 3.35 4.4 44.76
3.7 19.92 3.9 19.82 -27.3 0.10 0.9 34.76 -6.5 1.01 2.9 24.37 -5.0 6.11 0.7 3.27 4.3 45.32
3.3 20.05 3.7 19.99 -66.4 0.07 3.7 33.75 51.0 1.48 3.5 24.45 -3.3 4.52 4.3 3.31 5.4 46.19
3.8 19.88 3.7 19.80 23.2 0.08 3.8 33.46 16.8 1.65 4.2 24.34 -2.6 4.20 3.2 3.26 5.8 46.66
4.9 19.64 4.8 19.54 29.8 0.10 5.3 33.20 4.3 1.62 5.0 24.07 8.9 4.31 3.9 3.19 7.3 47.16
3.5
8.2 6.17 3.9 15.15 13.0 4.87
6.5 6.60 2.4 15.61 4.4 5.12
5.3 6.72 4.9 15.84 1.9 5.04
10.4 7.01 5.2 15.72 0.9 4.80
8.8 7.41 5.6 16.12 1.2 4.72
8.9 7.82 5.8 16.53 3.4 4.74
8.6 8.11 5.7 16.69 7.1 4.84
12.2 8.58 6.8 16.78 8.4 4.95
4.1 5.37 5.0 6.86 5.9 5.19
3.8 5.30 4.8 6.83 2.5 5.06
1.6 5.41 4.7 7.19 2.3 5.21
0.6 5.27 5.8 7.36 3.1 3.76
0.0 4.97 4.8 7.28 1.7 5.19
-0.5 4.80 4.4 7.38 0.9 4.88
1.7 4.74 5.5 7.55 4.7 4.81
4.0 4.71 5.1 7.59 2.9 4.72
6.0 4.70 6.8 7.63 1.6 4.52
3.8 77.66 5.6 8.20 3.5 23.33 29.4 23.7 8.0
4.6 76.76 4.1 8.07 12.5 24.78 17.7 20.8 9.1
5.0 76.62 4.6 8.03 11.7 26.32 22.8 14.0 5.9
3.4 79.73 -1.9 7.92 -16.3 22.16 16.9 -18.8 9.7
2.6 79.13 6.7 8.17 -2.0 21.01 18.8 4.1 6.7
3.5 77.30 6.1 8.19 11.4 22.08 8.7 2.1 4.3
3.6 77.77 -5.3 7.53 13.6 24.36 -15.6 -5.9 6.1
4.1 78.49 2.4 7.03 -3.5 20.38 9.5 7.2 2.9
5.3 78.93 0.5 6.75 0.1 19.48 2.9 5.8 3.0
5.8 78.76 -0.8 6.31 12.7 20.68 9.3 7.5* 5.5
8.0 10.0 5.5-6.0
11.8
12.3
12.9
15.0
10.0
9.9
9.7
5.5
5.9
6.2
6.8
25.7
26.2
29.5
40.9
39.1
44.2
51.0
51.6
54.2
56.0
54.5
4.8 15.0 3.8 8.0 4.0 7.0
5.2 0.0 10.0
January to November Source: National Accounts of the Philippines, National Statistical Coordination Board; Selected Philippine Economic Indicators, Bangko Sentral ng Pilipinas; Forecasts of J.T. Yap
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DEVELOPMENT RESEARCH NEWS
services sector will likely continue with its recent surge and the output growth trend of the agriculture sector has definitely shifted upwards. GDP growth is expected to post 5.6 percent in 2005, higher than the forecasts of most analysts but lower than the National Economic and Development Authority (NEDA)target of 5.8 to 6.3 percent.2 Recent economic performance Consumption expenditure was the main driver of economic activity in 2004, reaching its highest growth rate since 1988. (Refer to Table 1 for more details.) The fastest growing sectors were transportation and communication followed by food and beverages, with election spending contributing to the latter. Spending on fuel, light and water experienced lower growth owing to higher fuel prices and the hike in power rates. Higher OCW remittances combined with a weaker peso contributed to the surge in consumption. Meanwhile, investment spending grew at a robust 12.7 percent in 2004, a pattern observed across East Asia. Investment spending among the five countries hardest hit by the 1997 financial crisis had shown remarkable consistency recently (Table 2). For example, the contribution of fixed investment to GDP growth in the Philippines was positive for five consecutive quarters (Q3,2003 to Q3,2004), the first time this has happened since the onset of the crisis in July 1997. Several factors contributed to the strengthening of fixed investment in the region. First, the international environment between 2002 and 2004 has been conducive to global trade leading to
2
Among GDP forecasts for 2005 that have been published are IMF: 4.2 percent; ADB: 5.5 percent; IDE-JETRO: 5.5 percent and World Bank: 4.5 percent.
January - February 2005
higher export growth. Higher exports combined with increased consumer spending led to improved corporate profitability. Second, intense efforts aimed at financial and corporate restructuring have yielded positive results. Firms took advantage of these Table 2. Contribution of gross fixed investment to economic growth Indonesia
Korea
Malaysia
Philippines
Thailand
Q3 2004
2.54
0.89
0.90
1.04
2.60
Q2 2004
2.38
1.40
1.04
1.21
2.77
Q1 2004
1.61
0.49
0.99
1.85
3.21
Q4 2003
-0.11
1.13
1.01
0.23
3.63
Q3 2003
0.25
0.78
0.92
1.17
2.38
Q2 2003
0.42
1.15
0.12
-0.16
1.89
Q1 2003
0.96
1.25
1.07
1.25
1.47
Q4 2002
1.62
2.81
2.69
-1.77
1.51
Q3 2002
1.70
0.74
0.81
-1.74
1.63
Q2 2002
-0.41
2.24
-0.64
-1.77
1.51
Q1 2002
-1.17
2.04
-2.62
-2.56
0.51
Q4 2001
-0.49
1.90
-2.35
-0.64
-0.06
Q3 2001
0.11
-0.15
-3.28
-2.39
0.62
Q2 2001
2.22
-1.16
0.07
0.70
1.23
Q1 2001
3.43
-1.07
2.44
-1.35
-0.81
Q4 2000
3.82
1.08
3.46
4.43
0.52
Q3 2000
4.13
3.36
8.96
4.83
-0.20
Q2 2000
3.60
4.67
8.93
3.65
-0.41
Q1 2000
1.94
6.20
6.18
4.46
4.36
Q4 1999
1.54
3.97
1.62
-0.06
1.08
Q3 1999
-3.78
3.21
2.76
0.34
0.89
Q2 1999
-5.18
2.96
-3.46
0.08
1.20
Q1 1999
-10.04
-0.40
-8.85
-2.51
-63.89
Q4 1998
-13.15
-7.40
-21.23
-5.08
-10.65
Q3 1998
-12.37
-9.83
-29.57
-4.19
-18.19
Q2 1998
-11.74
-9.43
-21.96
-2.21
-17.54
Q1 1998
-5.09
-6.99
-10.84
0.33
39.88
Q4 1997
-0.31
-3.03
1.15
1.95
-16.78
Q3 1997
0.25
-1.80
9.20
3.29
-6.81
Q2 1997
5.26
1.29
6.54
2.72
-6.39
Q1 1997
5.94
0.34
0.64
3.36
-4.65
I
GDP
−1 Note: Contribution to growth is calculated as GDP GDP − 1 * 100 −1 −1 Source: Asia Regional Information Center
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DEVELOPMENT RESEARCH NEWS
January - February 2005
programs to reduce excessive debt and improve profitability. And third, macroeconomic conditions in most countries have stabilized and have become supportive of investment growth. In the case of the Philippines, public construction received a boost in the first half of 2004 from election-related spending. However, there was marked deceleration in fixed investment in the Philippines in the fourth quarter. One reason for the slowdown was the contraction of public construction in the last quarter of 2004. Investor confidence was also shaken by the declaration of a fiscal crisis and the rise in inflation. On the production side, the services sector registered a hefty 7.3 percent growth rate. Reflecting trends in consumption spending, the fastest growing subsector was transport, communications, and storage. Rapid technological developments, intense competition, and the growing need for communications services underpinned the strong expansion of the telecommunications sector. Financial services had its second consecutive year of strong growth although the main sources of income remain to be government securities and fee-based transactions. Retail trade also experienced accelerated growth. Meanwhile, the manufacturing sector benefited from higher agriculture growth, election spending, strong Table 3. GDP growth for major industrialized countries and regions
US Japan Euro Zone
2000
2001
2002
2003
2004e
2005f
4.1 2.4 3.7
0.8 0.2 1.6
1.9 -0.3 0.8
3.0 1.3 0.5
4.3 4.3 1.8
3.2 1.8 2.1
e – estimate; f – forecast Source: various World Bank reports; World Bank Global Economic Prospects 2005
exports, and a surprisingly brisk Christmas holiday season. These factors translated into high growth in the food and beverages industry and electrical machinery. The sectors with unusually high growth in the fourth quarter of 2004 include: wood and cork products, furniture and fixtures, paper and paper products, publishing and printing, leather products, and rubber products. The furniture industry, in particular, has been enjoying robust growth for six consecutive quarters now (Q3,2003 to Q4,2004). This can be attributed to the strong export growth resulting from faster economic expansion in the US, Japan, and Europe (Table 3). In addition, innovative designs and the better use of traditional materials have increased the market share of local manufacturers. From the supply side, the forestry sector recorded high growth rates in 2003 and 2004. Strong agriculture growth for ten of the last eleven years is irrefutable evidence that the growth trend in this sector has shifted upwards. This can be attributed partly to increased productivity. However, the faster growth also coincided with the stronger economic protection that has been granted the sector. This has offset the unfair advantage enjoyed by the agriculture sectors of the US and certain European countries. Meanwhile, the peso depreciated sharply in 2004 owing to investor jitters about the public sector’s fiscal problems. Political tensions in the run-up to the May elections also contributed to the outflow of capital. However, the peso sharply appreciated in the early part of 2005 and the exchange rate stood at P54.70 as of February 4, 2005. The rebound of the peso is largely attributable to the inflow of hot money, which has also fueled the resurgence of the stock market. Portfolio investors
DEVELOPMENT RESEARCH NEWS
have turned their attention to Philippine equities since it is only one of two countries—the other is Malaysia, which has imposed a reserve requirement on short-term capital—among the five hardest hit economies where stock prices are still below the pre-crisis levels. Due to the hike in fuel prices and sharp peso depreciation, inflation averaged 5.5 percent in 2004, reaching a peak of 7.9 percent in December (using 1994 as the base year for the consumer price index or CPI). The situation was exacerbated by the typhoons that hit the Philippines, especially in the last quarter of the year. Despite the rise in inflation, the 91-day Treasury Bill rate rose only marginally. This reflects the weak credit demand that still persists in the economy. The peso’s depreciation helped boost exports, which grew by 9.9 percent in nominal dollar terms during the first eleven months of 2004. However, the main driving force was the strong growth of the Philippines’ major trading partners. Exports to China have also increased rapidly in the past five years. Meanwhile, import growth also rose in 2004 due to the expansion in exports and robust output and investment growth. Key global issues The momentum generated by the relatively strong economic growth in 2004 will help the Philippines weather adverse global developments in the short-term. Meanwhile, economic reforms must be accelerated to enable the Philippines to address the global challenges and take advantage of the opportunities in the medium-term. These will be discussed shortly. Short-term developments Perhaps the biggest global economic
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January - February 2005
...The peso depreciated sharply in 2004 owing to investor jitters about the public sector’s fiscal problems. Political tensions in the run-up to the May elections also contributed to the outflow of capital. However, the peso sharply appreciated in the early part of 2005 and the exchange rate stood at P54.70 as of February 4, 2005. The rebound of the peso is largely attributable to the inflow of hot money, which has also fueled the resurgence of the stock market.
adjustment in 2005 will be triggered by the elimination of quotas in the garment and textile industry under the World Trade Organization’s Agreement on Textiles and Clothing (Box 1). The impact on the Philippine economy should not be that large, though, owing to the decline in the garment and textile industry in the past two decades. However, studies have shown that the restructuring process will provide garment manufacturers with ample opportunities to recoup. But this depends on the adjustments that have been made by the industry and government during the past 10 years. The recovery in industrialized economies that was vital to global economic growth in 2002-2004 appears to have lost steam (Table 3). After experiencing rapid productivity growth, a rebound in corporate profits, wealth gains due to higher equity and housing prices, and a fiscal stimulus from lower taxes, the United States (US) economy is showing signs of a slowdown. Lower consumption expenditure will likely lead to a decline in the GDP growth rate in 2005. Flagging consumer confidence is a reflection of the structural problems of the US economy that include an extremely low net national saving rate, a record high current account deficit, a large fiscal deficit, a near-zero personal
DEVELOPMENT RESEARCH NEWS
6
saving ratio, a negative household financial balance, and rapid household debt growth. Meanwhile, residential and business investments will likely cushion the impact of lower consumption expenditure. However, the investment cycle in the US will likely peak in the first quarter of 2005. The economic resurgence in Japan in the first half of 2004 fizzled out. Nevertheless, the recovery in corporate profits and business investment combined with strong export growth—particularly to China—resulted in a 4.3 percent rise in real GDP last year. Excess capacity and rising inventories in the electronics sector are expected to pull down economic activity in 2005. Recent surveys have shown a sharp fall in investor confidence. Meanwhile, exports in the Euro area benefited from the strong growth in Japan and the US, resulting in an aggregate GDP growth of 1.8 percent in 2004. However, economic performance was muted by the strong Euro, higher oil prices, and tighter budgetary policy in order to comply with the Stability Pact. An expected interest rate cut by the European Central Bank will boost investment and the region should benefit from closer economic ties with the Accession countries.
The greatest global risk remains to be the macroeconomic imbalances of the US...The record-high US current account deficit and a ballooning US net foreign liability position pose global risks, especially to financial markets, because of the possibility of a disorderly exchange rate adjustment. This will undermine the dollar’s status as a reserve currency.
January - February 2005
Moreover, there are strong indications that labor productivity growth in the Euro area—which lagged behind the US between1995-2003—is beginning to improve. While the pick-up is largely cyclical, that is, it is in line with GDP recovery, higher growth in labor productivity can be sustained if it is reinforced by technological progress in the information technology (IT) sector. The forecast 2.1 percent GDP growth in 2005 is higher than last year but is still lower than the global average. The unfavorable outlook for industrialized countries is aggravated by high fuel prices, the threat of higher international interest rates, and the likelihood of a downturn in the global electronics market. The latter has been substantiated by a deceleration in worldwide sales, a build-up of inventories, and weak new orders. However, the depth and duration of the downswing in the global electronics market is still unclear. Macroeconomic imbalances in the US have exerted upward pressure on interest rates. The Fed funds rate was increased five times in 2004 but this did not prevent the US dollar from depreciating last year. However, the large net foreign liability position of the US will discourage further upward adjustment, and, at most, the stance of the Federal Reserve will be ‘neutral’ and will not shift to ‘tight.’ Moreover, the US dollar appreciated against the euro and remained stable against the yen in January 2005, indicating that the earlier adjustments had some impact. The probability of higher international interest rates this year is therefore low. After hitting record highs in nominal terms, oil prices have eased since November 2004. However, because spare capacity is at historical lows and
DEVELOPMENT RESEARCH NEWS
concentrated in one country, the oil market remains vulnerable to supply side shocks, particular those that are geopolitical in nature. One practical course of action is for major consumers to restrain their demand through energy-saving measures. Finally, East Asia has increasingly benefited from the rapid economic growth of China. Exports of East Asian countries to China have risen dramatically over the past five years. Hence, recent reports that China’s economic managers are engineering a "soft landing" do not augur well for the export sectors in the region. A more serious downside risk is the possibility that the slowdown will not be smooth, and this can prove disruptive to the economies of the region. Medium-term developments The greatest global risk remains to be the macroeconomic imbalances of the US. As pointed out in last year’s report, the record-high US current account deficit and a ballooning US net foreign liability position pose global risks, especially to financial markets, because of the possibility of a disorderly exchange rate adjustment. This will undermine the dollar’s status as a reserve currency. What is more troublesome is that recent studies have shown that large but reasonable changes in the value of the US dollar have very little impact on the
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January - February 2005
Box 1. The impact of the elimination of quotas on garments and textiles For more than 30 years, the exports of textiles and garments between developed and developing countries had been stringently regulated by quotas under the Multi-fiber Agreement. However, beginning 2005, quotas will be eliminated under the World Trade Organization’s Agreement on Textiles and Clothing (ATC). In a study by the IMF and World Bank using the GTAP model, simulations suggested that the removal of quotas could generate income gains to developing countries of about $24 billion a year and export revenue gains of $40 billion. Moreover, the removal of quota could also create 27 million jobs.* The elimination of quotas will likely result in a shift of garment production to countries that are more competitive in the manufacturing of garments. There will also be a shift in textile production toward developing countries, thus generating a positive net impact for developing countries. In 2000, developing countries accounted for 60 percent of the total world clothing exports and among the top exporters were China, India, Bangladesh, Thailand and Pakistan. In the various studies conducted on the impact of quota elimination under the ATC, it has been concluded that China will benefit the most along with other East Asian countries (Thailand, Indonesia, and Vietnam) and those in South Asia (Pakistan, India, Bangladesh, and Sri Lanka). In addition, when the US International Trade Commission modeled the effects of the quota removal, it concluded that all regions of the world would lose market share to China. Garment exports of the Philippines peaked in 1992, with a 21.8 percent share of total exports. In 2003, the share was 6.3 percent, equivalent to about $2.5 billion. The elimination of quotas is likely to increase the market access of the Philippines in the world market, mostly in the industrialized or developed countries. An early study showed that the country will gain not only in terms of an increase in production and exports but also in terms of national welfare.** Although the Philippines will not be an immediate winner due to the lack of cost advantage to compete with China, Indonesia, Viet Nam, India and others, it can still fully utilize the advantages that we have like flexible labor and excellent interpersonal and communication skills. However, the gains will be realized only if the measures put in place during the 10-year gradual phase-out period are effective. In preparation for the quota phase-out, the Philippine government put in place the Industry Transformation Plan to make textile and garment businesses more competitive. The focal point of the plan was to reduce administrative costs and provide development assistance programs to boost both the quantity and value of local production. Moreover, financial assistance schemes were instituted to improve credit access and facilitate cash flows for small and medium scale exporters. Trade facilitation measures were also established like the paperless visa applications and the reduced custom clearance time via the green-lane at the Bureau of Customs for raw materials importation. Most importantly, consultations between the government and the private sector were initiated for the purpose of enhancing the government programs to better serve the interest of the domestic textile and garment industry and address current problems like underground operations of sweatshops and transshipment activities.*** *International Monetary Fund and World Bank. 2002. Market access for developing country exports: selected issues. ** Austria, M. 1996. The effects of MFA phase-out on the Philippine garments and textile industries. PIDS Discussion Paper 96-07. ***Part of the last paragraph was obtained from “Country responses to the phase-out of the multifibre agreement.” Available at http://www.iccr.org/news/press_releases/countryresponsestomfaphaseout.PDF
DEVELOPMENT RESEARCH NEWS
8
current account deficit. The implication is that it is imperative for US policymakers to instigate interventions that will narrow the US deficits via quantity adjustments, especially fiscal consolidation measures. In other words, excessive aggregate demand must be brought down. If the US bears its share of the burden of adjustment, then East Asian economies will be spared the dilemma of supporting the US current account deficit at huge opportunity costs and at the same time having to deal with political pressure from the US to revalue their currencies. Inevitably—whatever course of action the US adopts—East Asian economies must accelerate their integration process in order to deal more effectively with the global challenges. This will entail three basic tracks: i) Northeast Asia will absorb more exports from Southeast Asia, including skilled labor; ii) the financial resources of the region that are generated by relatively high saving rates will be used primarily to accelerate the catch-up process of the less-developed economies; and iii) there will be an understanding among political leaders in the region that China will ultimately assume the leadership role.
If the US bears its share of the burden of adjustment, then East Asian economies will be spared the dilemma of supporting the US current account deficit at huge opportunity costs and at the same time having to deal with political pressure from the US to revalue their currencies. Inevitably—whatever course of action the US adopts—East Asian economies must accelerate their integration process in order to deal more effectively with the global challenges.
January - February 2005
The recent Japan-Philippines Economic Partnership Agreement and the Framework Agreement on ASEAN-China Comprehensive Economic Cooperation (ACCEC) are both integral components of the aforementioned process. In a bilateral meeting on November 29, 2004, President Macapagal-Arroyo and Prime Minister Koizumi confirmed that the Philippines and Japan reached an agreement in principle on the major elements of the JPEPA. The final agreement is expected to be signed in June 2005. Meanwhile, the ACCEC stipulates how ASEAN and China will cooperate in trade and investment liberalization facilitation and economic cooperation. It sets a 10-year period for negotiation and the major goal is an ASEAN-China Free Trade Area by 2015. This is the context in which the Philippines must prepare itself over the medium-term. The adjustment process entails reforms in all aspects of society: economic, political, and social. This is a golden opportunity and missing this chance will truly make the Philippines the “sick man of Asia.” Policy issues There are three major sets of policy issues that the government must address in the short-term. The first is the remaining agenda on the fiscal reform program. The second refers to measures that would improve the environment for private investment. The last set deals with social measures that are in line with the Millennium Development Goals. With the successful passage of the legislative bill increasing excise taxes on liquor and cigarettes and the lateral attrition bill, the government can tackle the remaining items in the fiscal reform agenda. These would include the following:
DEVELOPMENT RESEARCH NEWS
❃ Tax amnesty, which has already been passed by the House of Representatives on third reading; ❃ Rationalization of fiscal incentive, also passed on third reading by the House of Representatives; ❃ An increase in the excise tax on petroleum products; ❃ A franchise tax on telecommunication; and ❃ Simplified Net Income Tax System.
Despite the positive impact of these measures on the budget deficit, policymakers must still find a quicker and more effective solution to the huge debt overhang. As mentioned in last year’s outlook issue, one course of action is to invoke the Odious Debt Doctrine. The rebound in private investment, meanwhile, must be nurtured in order for economic growth to be sustained. A recent publication of the World Bank makes the following conclusion, from which policy measures can be drawn:3 “This paper asks what government in the East Asia and Pacific Region can do to accelerate private investment growth. Results of the investment climate assessments conducted in the region suggest that in Indonesia and the Philippines, policy related risks seem to be the most binding constraint to investment. Upholding property rights, reducing the regulatory burden, keeping the commitment to current rules of the game and reducing macroeconomic instability would help. In countries such as the Philippines
3 World Bank East Asia Update 2004, Special Focus: Strengthening the Investment Climate in East Asia, page 61. http://siteresources.worldbank.org/INTEAPHALFYEARLY UPDATE/Resources/EAPupdatefinalNov04.pdf
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January - February 2005
Despite the positive impact of these measures on the budget deficit, policymakers must still find a quicker and more effective solution to the huge debt overhang. As mentioned in last year’s outlook issue, one course of action is to invoke the Odious Debt Doctrine.
and Cambodia, the high cost of business stemming from poor governance and corruption, and poor physical and financial infrastructure appear to be holding back investment. Revamping investment would require curbing corruption, ensuring a reliable supply of power, and better access to finance. In Malaysia and, to a certain extent, in China, skills shortages appear to be a key impediment to higher innovation and investment returns. Further improving the quality of educational output could be critical in boosting returns to investment and accelerating private investment recovery.” The recent decision of the Philippine Supreme Court upholding the constitutionality of the Mining Act is one example of a measure that reduces policyrelated risks by clarifying the rules of the game. Meanwhile, the proposed Corporate Recovery Act (CRA) seeks to streamline and make more equitable the process in which the problems of insolvent enterprises are resolved. The CRA clarifies the rights of debtors and creditors to initiate formal debt relief proceedings. The House version of the bill is on pending status with the committee on banks while the Senate has conducted two hearings on its proposed version. A related proposal is the establishment of a Credit Informa- )14
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Governance in Southeast Asia Prior to 1997, the Southeast Asian nations' excellent economic surge was in part attributed to their good governance. As a group, they showed an average annual gross national product (GNP) growth rate of six percent, more than three times the record of the Organization for Economic Cooperation and Development (OECD) countries in 1990 and 1998, thereby making the region an important force in the world economy. Governance gains, however, turned out to be a little overrrated when corruption and poor resource management, considered as dormant afflictions, were uncovered after the financial meltdown in 1997. The severe recession that followed in 1998 highlighted the typical symptoms of government failures: weak checks and balances, excessive regulations, and policies that handicapped competition, among others. Worse, the weak governance and poorly functioning public institutions provoked new problems in the form of challenges for changes in political leadership in some of the countries affected. What then should be done?
There is a solid connection between good governance and the economic success of a nation, the reason why after the economic shock of 1997, some Southeast Asian nations were still able to carry the fall as shown by Singapore and Malaysia.
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In the book, Governance in Southeast Asia: Issues and Options* by Eduardo T. Gonzalez and Magdalena L. Mendoza, the authors state that “to accelerate broad-based and equitable growth and prevent another economic shock, the region needs major reforms in governance and public institutions.” But what is governance? How important is it to attain political and economic stability for the Southeast Asian region? Governance is the exercise of economic, political and administrative power in the management of the resources of a state. When used, it requires mechanisms, processes, and institutions where citizens and groups express their interests, exercise their legal rights, meet their obligations, and reconcile their differences. There are three critical players in governance—state, private sector, and civil society—important for sustainable growth and human development. The State creates the positive political and legal environment while the private sector generates jobs and income. Civil society expedites the political and social interaction. Governance and the economy Indeed, there is a solid connection between good governance and the economic success of a nation, the reason why after the economic shock of 1997, some Southeast Asian nations were still able to carry the fall as shown by Singapore and Malaysia. In Figure 1, these countries’ high-performing economies are shown to be accompanied by a high governance index. Those that lagged behind like Indonesia and the Philippines, on the other hand, are seen to have poor management struc* Appeared as Research Paper Series 2002-06, published by the Philippine Isntitute for Development Studies.
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To add, Indonesia’s and the Philippines’ corruption and high inflation levels are in stark contrast to Singapore’s and Malaysia’s edge in public management as gleaned from the latter’s improved tax effort and high priority spending in health and education. Now, nearly a decade after the economic downturn in Asia, pressures for better management remains crucial in the region. Major changes in governance and strengthening of institutional weakness are a “must” in forging economic resiliency and stalling external shocks from becoming major crises. Interrelationship between political and economic governance Perhaps what emerged as striking realizations from the 1997-1998 financial crisis were the weak points in the judicial system and the extent of corruption in the various levels of government. Prior to the Asian crisis, there was a positive perception of the rule of law in the region. As many countries in the region experienced tremendous growth, confidence in their legal institutions also grew. The financial crisis, however, uncovered many misperceptions. One is the fact that judicial independence was grossly compromised and another is that corruption rose to unprecedented levels. Corruption and weak judicial system are partners in crime which, in turn, destabilize a country’s institutional defenses (Mauro 1997). This is true even in the successful economies of Southeast Asia. Table 1 shows that while Asia as a whole is not highly rated on both corruption and weak judicial
Figure 1. Good governance and growth go together
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GDP Ave Annual % Growth, 1990-2000
tures and governance. The poor economic performances of the latter two countries were also attributed to their rigid regulatory structures and restrictive trade regimes.
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8
Singapore
Malaysia
7 6
South Korea
5
Indonesia
4 3
Thailand Philippines Sources: Huther and Shah
2 1 0 30
35
40
45
50
55
Good Govenance Index Source: Huther and Shah, 2000; World Development Report 2002
system, it is, however, the trio of the Southeast Asian countries of Indonesia, Malaysia and the Philippines plus China that has pulled down the region’s overall ranking. Indonesia and the Philippines are among the bottom dwellers worldwide because rentseekers have often been successful in undermining the institutions designed to keep them out. These scenarios have been prevalent even in the precrisis period of 1997 and have definitely hurt the economic governance of countries in the region. Unreliable institutions force entrepreneurs to either “hit and run,” that is to invest in risky, speculative activities that offer high returns but allow them instant exit once they sense trouble. Or they could “play it safe,” that is, to invest in long-term projects that give lower returns but require less capital outlay. Moreover, corruption has distorted the policy environment and many public officials have been said to manipulate rules for their interests. The judiciary, on the other hand, has been weakened, making it unable to provide the credible threat of punishment when official misconduct is known.
60
65
70
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DEVELOPMENT RESEARCH NEWS Table 1. Civil instititions take the beating in East and Southeast Asia
January - February 2005
Another crucial area in need of efficient political governance is the problem of conflict management affecting some nations in the Southeast Asia. In the 1970s, the quality of institutions for conflict management have greatly affected growth as revealed in studies.
east Asian economies are suffering from “reform fatigue.” The introduction of new and urgent interventions and remedies will thus most likely face resistance. Such resistance though will not come because of the radical changes introduced but because of the inadequate institutional capacity of the countries to absorb them. Phasing of the reform package will then be crucial to answer the important needs of Southeast Asia in reducing poverty and resolving internal conflicts. Reforms in the public sector should thus center on public finance, legal institutions and the judiciary, among others, because these are the core institutions.
As said, societies with ethnic fragmentation, worsened by low-quality institutions for managing conflict, tend to blow up external shocks, thereby creating distributional conflicts and delaying policy responses. Indonesia and the Philippines are both experiencing unsteady growth rates because of the high degree of ethnic tensions in them. In these countries, prolonged conflicts have curtailed basic social services and economic opportunities to affected areas. As a result, majority in said areas suffer from a lower standard of living. Institutions that benefit the poor are thus needed to ensure successful conflict management.
The Southeast Asian 5—Singapore, Malaysia, Indonesia, Thailand and the Philippines—will definitely have different reforms in their governance as compared to other nations in the region. They have more managerial capacity, developed democratic systems and governance structure that would only need assistance in institutional strengthening as opposed to the transition states of Vietnam, Laos and Cambodia as well as Myanmar. The latter have a lot to achieve in the areas of private sector and civil society participation in governance and will need more help in developing their institutions, public management capacities and participation technology.
Ranking of 53 countries worldwide Judicial independence
Corruption
Indonesia
51
52
Philippines
47
51
Malaysia
30
45
China
29
41
Taiwan
16
33
South Korea
15
28
Tahiland
13
23
Source: World Competitiveness Report 1998
A strong civil society for its part is a handy companion for growth and development because it can pressure the quality of government service especially for the poor and marginalized sectors in the areas where ethnic conflicts exist. Broader participation empowers people, brings social capital to play in economic development and makes government more responsive to people’s needs. Recommendations It is to be noted that many of the South-
On the other hand, regardless of the different pace of development of Southeast Asia, there is a need to establish and strengthen transparency and accountability structure. The key assignment of the central government is to steer the macroeconomic management while the private sector and civil society can do the rowing. This means rightsizing the government by pushing for privatization to reduce strain on public finances and raise private sector efficiency and accountability.
DEVELOPMENT RESEARCH NEWS
Rightsizing of Southeast Asian governments, however, must be done with caution. For example, Thailand and the Philippines both have big numbers of people in their governments and a bit of expansion or redeployment may have to take place before they can slim it down. This way, a balance between size of government, growth and human welfare will be achieved. The governments of Southeast Asia also need to generate revenue to fulfill their responsibility especially for basic social services. Tax reform efficiency and management then is a very important part of the governance package in the region. Examples are Indonesia, the Philippines, and the transition economies in Southeast Asia that are facing tough challenges in raising revenues through better tax administration and fiscal management. Private sector accountability should also increase in a way that its obligations are self-guaranteed. This will prevent the government from giving bailout options in case of default. This is also where corporate governance comes in thereby increasing disclosure and protecting public interest in listed corporations and state-owned enterprises. High levels of corruption also weaken the legitimacy of a number of countries in the region and damage their capacities to provide institutions with support growth and development. A national anticorruption plan, owned and sponsored by central government officials, can therefore help prevent wastage of government resources and “state capture.” It is also a strong accountability mechanism. More importantly, the ultimate guarantor of accountability, which is the judiciary, must always be secured. Ideally, when everything fails, the last
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recourse for arbitration and meditation is the judiciary. A turnaround in Southeast Asia would require further development of the legal systems and reforms to enhance judicial independence and raise judicial efficiency. Enabling and transmission mechanisms are also crucial for the effective enforcement of governance. For one, to curb arbitrariness in government actions, institutions that limit the state’s capacity for arbitrary action will improve its ability to provide support-based markets. Reforms in civil service can include meritocracy, development of management cadres, and quality orientation for frontline service personnel. Alternative delivery mechanisms to widen people’s access to basic services should also be adopted. In this, private sector firms or civil society organizations can serve as government substitute. These delivery mechanisms can also be enhanced by devolving the provisions of basic services like basic education and health to subnational governments. More efficient public institutions are also crucial in bridging the gap in the rise of ethnic tensions in Southeast Asia. In Indonesia and the Philippines )16 wherein ethnic conflicts are high,
High levels of corruption also weaken the legitimacy of a number of countries in the region and damage their capacities to provide institutions with support growth and development. A national anticorruption plan, owned and sponsored by central government officials, can therefore help prevent wastage of government resources and “state capture.” It is also a strong accountability mechanism.
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tion Bureau to improve the quality of loans, lower the cost of credit, and increase access of small borrowers. The CRA—especially in tandem with the Special Purpose Vehicle (SPV) Law— and Credit Information Bureau are examples of measures to enhance access to finance. The third set of issues relates to programs that are aimed at achieving the Millennium Development Goals. It is acknowledged that social outcomes such as reduction in infant mortality rates take time before they are realized. However, the UNDP identified QuickWin interventions, as seen in Box 2 which, if implemented, can yield largescale progress almost immediately. It would be useful for policymakers to examine these proposals and identify those that can be readily implemented in the Philippine context. Outlook for 2005 More fiscal measures are likely to be enacted in the first half of 2005 and the momentum of policy reform will likely spill over to other areas (e.g. governance and corruption). However, there will likely be no major structural changes that will generate higher economic growth (e.g. drastically improved physical infrastructure). Nevertheless, the additional reforms should boost investor confidence. This will be supported by more rapid credit growth resulting from healthier bank balance sheets. Public investment should be a contributing factor given the public investment projects in the pipeline: the North Rail, Subic-Clark-Tarlac Expressway and the extension of the existing light rail transit systems. Capital formation will expand at an estimated 10 percent.
Meanwhile, persistent high fuel prices and higher taxes will dampen consumption expenditures, which will still grow by a robust 5.4 percent. Because of these same factors, inflation will average between 5.5 and 6 percent in 2005, although there will be a distinct downward trend in the second half of the year. Mainly because of the higher inflation rate and a slight recovery in credit demand, the 91-day Treasury Bill rate will inch up to an average of 6.8 percent. The main driver of economic growth, though, will still be the services sector, which should expand at a comfortable seven percent. Apart from the usual contribution of the telecommunications sector, the tourism industry will receive a boost—albeit an unwelcome one— from the disaster that befell tourist destinations along the Indian Ocean. The agriculture sector will be adversely affected by the predicted El Niño in the first quarter of 2005. Full year growth is expected to drop to 3.5 percent. The industry sector should benefit greatly from initial investments in the mining sector. Foreign direct investment in the mining sector will be one reason the peso will strengthen and average about P54 this year. However, the manufacturing sector will be negatively affected by the lower agriculture growth and downturn in the global electronics industry. The latter, along with lower growth in the US, Japan, and China, will push down export growth in 2005. Overall, GDP growth in 2005 will remain relatively strong at 5.6 percent. However, scheduled higher debt service and an expected slowdown in OFW remittances will drag down GNP growth. The latter is forecast to be 5.4 percent in 2005. DRN
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January - February 2005
Box 2. Quick-win measures* ❃ Eliminate school and uniform fees to ensure that all children, especially girls, are not out of school because of their families’ poverty. Lost revenues should be replaced with more equitable and efficient sources of finance, including donor assistance. ❃ Provide impoverished farmers in sub-Saharan Africa with affordable replenishments of soil nitrogen and other soil nutrients. ❃ Provide free school meals for all children using locally produced foods with take-home rations. ❃ Design community nutrition programs that support breastfeeding and provide access to locally produced complementary foods and, where needed, micronutrient (especially zinc and vitamin A) supplementation for pregnant and lactating women and children under five. ❃ Provide regular annual deworming to all schoolchildren in affected areas to improve health and educational outcomes. ❃ Train large numbers of village workers in health, farming, and infrastructure (in one-year programs) to provide basic expertise and services to rural communities. ❃ Distribute free, long-lasting, insecticide-treated bednets to all children in malaria-endemic zones to cut decisively the burden of malaria. ❃ Eliminate user fees for basic health services in all developing countries, financed by increased domestic and donor resources for health. ❃ Expand access to sexual and reproductive health information and services, including family planning and contraceptive information and services, and close existing funding gaps for supplies and logistics. ❃ Expand the use of proven effective drug combinations for AIDS, TB, and malaria. For AIDS, this includes successfully completing the 3 by 5 initiative to bring antiretroviral to 3 million people by 2005. ❃ Set up funding to finance community-based slum upgrading and earmark idle public land for low-cost housing. ❃ Provide access to electricity, water sanitation, and the internet for all hospitals, schools, and other social service institutions using off-grid diesel generators, solar panels, or other appropriate technologies. ❃ Reform and enforce legislation guaranteeing women and girls property and inheritance rights. ❃ Launch national campaigns to reduce violence against women. ❃ Establish, in each country, an office of science advisor to the president or prime minister to consolidate the role of science in national policymaking. ❃ Empower women to play a central role in formulating and monitoring MDG-based poverty reduction strategies and other critical policy reform processes, particularly at the level of local governments. ❃ Provide community-level support to plant trees to provide soil nutrients, fuelwood, shade, fodder, watershed protection, windbreak, and timber. Of course, these quick-wins alone will not achieve the MDGs. They need to be matched by investment strategies with longer timeframes, such as those for transport infrastructure, energy services, and teacher and nurse training. But they represent a feasible and immediate set of actions that could begin today and could save and improve millions of lives around the developing world.These strategies do not require complex systems or extensive infrastructure for their delivery. Time-tested, they have proven their effectiveness in the poorest of countries. To succeed, they need to be customized and implemented by developing countries and supported by immediate and adequate financial and technical assistance from the rich countries. It should be emphasized that they are not the only interventions required to reach the MDGs—just ones with very high impact in the short term. The world cannot afford to let another year go by without investing in these simple and proven strategies. *Lifted from Box 5.1 of the United Nations Development Programme (UNDP) publication Investing in development: a practical plan to achieve the millennium development goals. http://unmp@forumone.com.
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STAFF BOX Editorial Board: Dr. Mario B. Lamberte, President; Dr. Gilberto M. Llanto, Vice-President; Mr. Mario C. Feranil, Director for Project Services and Development; Ms. Jennifer P.T. Liguton, Director for
January - February 2005
DEVELOPMENT RESEARCH NEWS is a bimonthly publication of the PHILIPPINE INSTITUTE FOR DEVELOPMENT STUDIES (PIDS). It highlights the findings and recommendations of PIDS research projects and important policy issues discussed during PIDS seminars. PIDS is a nonstock, nonprofit government research institution engaged in long-term, policy-oriented research. This publication is part of the Institute's program to disseminate information to promote the use of research findings. The views and opinions expressed here are those of the authors and do not necessarily reflect those of the Institute. Inquiries regarding any of the studies contained in this publication, or any of the PIDS papers, as well as suggestions or comments are welcome. Please address all correspondence and inquiries to:
DEVELOPMENT RESEARCH NEWS Vol. XXIII No. 1 January - February 2005 ISSN 0115 - 9097
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Governance from page 13
Exchange; Delia S. Romero, Galicano ○
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A. Godes, Necita Z. Aquino and
CONGRATULATIONS!!
Alejandro P. Manalili, Circulation and Subscription; Genna J. Estrabon, Layout and Design.
peacebuilding efforts and reforms to address the poor living conditions, poor infrastructure, inferior access to education, among others, are a must. Negotiations and peace talks are indeed important but access to the basic services will definitely accelerate the peace process in these areas. In the end, it is noteworthy to stress that commitment, coupled with political will from the leaders of the region, will strengthen governance and determine whether Southeast Asia will have a bright future or not. DRN References Gonzalez, E. and M. Mendoza. 2002. Governance in Southeast Asia: Issues and Options. PIDS Research Paper Series No. 2002-06. Makati City: Philippine Institute for Development Studies. Mauro, P. 1997. The effects of corruption on growth, investment and government expenditure. IMF Working Paper 96/98. Washington, D.C.: IMF Publication Services.
Dr. Josef T. Yap, senior research fellow at the Philippine Institute for Development Studies, was appointed by President Gloria Macapagal-Arroyo as Acting Member of the Committee on Social and Human Sciences to the UNESCO National Commission (UNACOM) of the Philippines beginning November 26. 2004.