PHILIPPI NE INSTITUTE FOR DEVELOPMENT STUDIES Surian sa mga Pag-aaral Pangkaunlaran ng Pilipinas
Vol. XXVII No.1
Editor's Notes Gross domestic product (GDP) growth will likely be lower in 2009. As this can be expected following the global economic crisis of 2008, Philippine Institute for Development Studies (PIDS) President Dr. Josef T. Yap, in this year’s economic outlook, focuses more on the extent of the slowdown on the Philippine economy. How our economy can withstand the shocks of the recent meltdown is a more important concern. Dr. Yap identifies the steady flow of remittances from
DEVELOPMENT RESEARCH NEWS January - February 2009
ISSN 0115-9097
The Philippine economy in 2008 and prospects for 2009 Josef T. Yap*
our Overseas Filipino Workers (OFWs), steady growth of the services sector, a boost from public construction activity, and a slowdown in the manufacturing sector as important factors that would support a projected growth rate of 4.3 percent in 2009. However, the economic seer underscores that there is still much to be done in terms of structural reforms so that our country will be able to hurdle the chal-
Introduction: a series of unfortunate events On the eve of a defining moment in its political landscape, the US was buffeted by a financial crisis, the scale of which was last seen during the Great Depression. This was preceded by a period of relatively high inflation in many economies caused by a surge in food and fuel prices.1 The overall result has been a synchronized global recession, particularly in industrialized economies. A great deal of uncertainty remains over the depth and duration of the current global economic downturn.
lenges at hand. In response to the global financial crisis, Dr. Yap enumerates policy measures that the Philippine government has undertaken so far. He likewise recommends policy measures that are regional in scope and would provide longer-term responses to the
These events did not spare the Philippine economy. After reaching a record growth rate in 2007, the Philippine economy decelerated sharply last year. GDP growth fell from 7.3 percent to 4.5 percent (Table 1). The slowdown in the Philippine economy was largely brought about by a surge in inflation and to a lesser extent, by the US recession which officially started in December 2007. Inflation jumped to 9.3 percent last year after averaging only 2.8 percent in 2007.
2008 economic crisis. Our initial DRN issue for this year focuses solely on this outlook in order to highlight what is critical for the country to weather the economic downturn. This outlook points to the fact that while the Philippine economy remains vulnerable to the impact of the global financial crisis, adopting a more proactive stance toward uncertainties, at this point, is still the best way to go.
DRN
It would be useful to distinguish the various elements and sources of the volatility of the global economy. This will enable policymakers to anticipate *President, Philippine Institute for Development Studies (PIDS). The contributions of Ms. Elizabeth S. Tan, Lecturer, Chinese Studies Program at the Ateneo de Manila University, and Ms. Fatima Lourdes E. del Prado, Research Specialist at PIDS, are gratefully acknowledged. Part of this outlook appears in a rapid assessment paper submitted by the author to the International Labor Organization. The usual disclaimer applies. 1 The subprime mortgage crisis, surge in fuel and food prices, and even the current global financial crisis have a common root cause: global excess liquidity caused by the unipolar financial system. For a brief description, see Yap (2008b). Meanwhile, primarily because of historical low correlations between US and Philippine GDP growth rates, it has been argued that the US recession will have minimal direct impact on the Philippine economy (Yap, 2008a).
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Table 1. Selected macroeconomic indicators, Philippines in 2009 Annual growth rates and share to GDP At constant 1985 prices, in percent unless otherwise indicated.
Gross National Product Gross Domestic Product Agriculture, Fishery and Forestry (share to GDP) Agriculture and fishery
2001
2002
2003
2004
2005
2006
2007
2008
Forecast 2009
2.26 2.96
4.31 3.12
5.82 5.04
6.91 6.38
5.33 4.87
6.10 5.45
7.80 7.33
6.1 4.5
5.0 4.3 2.5
3.69
3.80
3.92
5.18
2.02
19.92 3.92 19.82 (27.26) 0.10 0.91 34.76 (6.54) 1.01 2.87 24.37 (4.96) 6.11 0.67 3.27 4.25 45.32 8.81 7.41 5.61 16.12 1.23 4.72 (0.45) 4.80 4.40 7.38 0.94 4.88
20.05 3.97 19.99 (30.16) 0.07 0.15 33.75 50.96 1.48 3.47 24.45 (23.72) 4.52 4.26 3.31 5.10 46.19 8.93 7.82 5.76 16.53 3.44 4.74 1.72 4.74 5.49 7.55 1.46 4.81
19.84 3.85 19.76 24.10 0.08 4.25 33.50 16.82 1.65 4.24 24.26 0.96 4.34 3.19 3.25 6.11 46.66 8.59 8.09 5.66 16.63 5.88 4.77 4.10 4.70 8.12 7.78 2.70 4.70
19.62 4.98 19.50 53.29 0.11 5.21 33.13 2.62 1.59 5.84 24.14 3.41 4.22 4.23 3.18 7.73 47.25 11.23 8.46 6.78 16.69 9.88 4.93 5.30 4.65 10.65 8.09 0.49 4.44
19.08 2.01 18.97 4.15 0.11 3.78 32.79 9.32 1.65 5.28 24.23 (5.88) 3.79 2.48 3.11 6.81 48.13 7.34 8.65 5.64 16.82 13.61 5.34 5.32 4.67 7.52 8.29 2.96 4.36
3.83 18.79 3.87 18.69 (3.91) 0.10 4.55 32.51 (6.09) 1.47 4.60 24.04 7.33 3.86 6.39 3.14 6.70 48.70 6.34 8.73 6.10 16.92 11.36 5.64 5.71 4.68 6.92 8.41 4.71 4.33
5.08 18.39 5.04 18.29 12.13 0.11 6.61 32.29 25.01 1.72 3.34 23.14 19.49 4.29 7.21 3.14 8.68 49.32 8.23 8.80 9.80 17.31 12.26 5.90 6.02 4.62 8.76 8.52 3.29 4.16
3.2 18.1 3.2 18.0 2.3 0.1 5.0 32.7 0.6 1.7 4.3 23.1 8.2 4.7 7.7 3.2 4.9 49.2 3.7 8.7 4.7 17.1 4.9 6.0 7.0 4.7 5.7 8.6 4.7 4.1
Personal Consumption 3.58 Expenditure 77.77 (share to GDP) (5.32) Government Consumption 7.53 (share to GDP) (7.29) Capital Formation 22.12 (share to GDP) (15.57) Exports (nominal $) (4.16) Imports (nominal $) 6.8 Inflation (2000=100) (ave.) 9.9 91-Day Treasury Bill Rate (ave.) 50.99 Nominal Exchange Rate (ave)
4.07 78.49 (3.72) 7.03 (5.02) 20.38 9.51 18.69 3.0 5.4 51.60
5.28 78.67 2.49 6.86 3.77 20.13 2.91 3.15 3.4 6 54.20
5.88 78.30 1.39 6.54 7.17 20.28 9.52 8.82 5.7 7.3 56.04
4.84 78.28 1.61 6.33 (8.77) 17.64 3.97 7.67 7 6.4 55.08
5.45 78.28 6.13 6.37 2.69 17.18 14.92 9.19 5.50 5.4 51.31
6.03 77.33 10.02 6.53 9.29 17.49 6.45 7.22 2.80 3.4 46.15
4.5 77.2 4.3 6.7 4.2 18.1 -2.9 2.0 9.30 5.4 44.47
Forestry Industry Sector (share to GDP) Mining and quarrying Manufacturing Construction Electricity, Gas and Water Service Sector (share to GDP) Transport, communication and storage Trade Finance Ownership of dwellings and real estate Private services Government services
4.4 5.0 3.2 10.0 5.0 4.9 5.5 5.0 3.0 6.0 5.0 5.0 4.50 5.00 3.00 -5.0 4.0 4.8-5.3 4.00 47.00
Source: National Accounts of the Philippines, National Statistical Coordination Board; Selected Philippine Economic Indicators, Bangko Sentral ng Pilipinas; National Statistics Office; Forecasts of J. T. Yap.
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Table 2. Foreign-currency government bond spreads (EMBIG), end-of-period, in basis points over U.S. treasuries
China Indonesia Malaysia Philippines Vietnam
Mar-07 53 171 73 167 108
Jun-07 54 165 75 155 122
Sep-07 88 217 108 184 156
Dec-07 120 275 119 172 203
Mar-08 154 329 144 207 283
Jun-08 137 381 153 303 368
Sep-08 191 490 194 324 404
Note: EMBIG is the JP Morgan Emerging Markets Bond Index Source: World Bank, East Asia Economic Update, December 2008.
Figure 1. Monthly stock prices, Philippines: Jan 2000-Jan 2009
the likely impacts and implement the appropriate measures to mitigate any adverse effects. That the slowdown of the Philippine economy in 2008 is not directly related to the current global financial crisis and the ensuing recession in major economies should be a cause of concern. This implies that there is a huge downside risk for the economy in the coming months. Impact on asset markets The financial turmoil that emerged in the aftermath of the Lehman Brothers debacle magnified tensions in the global interbank and credit markets. As a result, there was a virtual freeze in liquidity in US and European financial markets which stopped and, in many cases, reversed capital flows to emerging and developing countries. In large part, the latter reflected sales of debt and equity securities by nonresidents,
selective withdrawals of bank deposits held with domestic banks, and a decline in inflows of foreign direct investment (World Bank, 2008). The immediate impact of the liquidity squeeze in international capital markets was a rise in the price of risk, as measured by bond spreads, a sharp drop in equity prices and exchange rate volatility. Data in Table 2 show that the foreign-currency government bond spread for the Philippines jumped from 155 basis points in June 2007 to 549 basis points in November 2008. Meanwhile, the main index of the Philippine stock market fell by 48 percent between December 2007 and December 2008 (Figure 1). The exchange rate also exhibited volatility with the peso depreciating against the US dollar by 19.1 percent between March
Oct-08 329 803 451 434 880
Nov-08 214 930 401 549 802
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January - February 2009
Figure 2. REER and ER, Philippines: Jan 2000 - December 2008 therefore, affect profitability of exporters rather than demand for their products. Profitability of exporters, however, has an impact on their investment and employment decisions. Exchange rate movements affect the propensity to import, the degree of protection of import-substituting industries, and the peso value of remittances from abroad.
1, 2008 and November 21, 2008 after appreciating by 39 percent between September 20, 2005 and February 29, 2008 (Figure 2). Thereafter, between November 21, 2008 and January 31, 2009, the peso appreciated by 6.9 percent. Monitoring the impact of these events on the real sector of the economy is important. Rising bond spreads will raise the cost of financing external debt with attendant effects on the fiscal position of the national government. However, higher interest payments are not expected to materialize in the short term. Meanwhile, portfolio flows have been shown to have a minimal impact on consumption and investment in the Philippines. Hence, the gyrations in the stock market are not expected to have major repercussions on the real sector. Stock market and exchange rate volatility do affect macroeconomic stability and this has implications for private investment. However, the investment rate in the Philippines has been sluggish for the past decade and there is not much room for further deterioration.
Impact on the financial sector The onset of the global financial crisis raised fears that many emerging markets will face a debacle similar to the 1997 financial crisis that hit East Asia. The initial impact on asset markets did put pressure on financial markets, especially in economies with high foreign participation in local equity markets, banking systems that depend heavily on short-term foreign currency funding, and those running external current account deficits (ADB, 2008). In East Asia, Korea and Indonesia experienced severe foreign currency liquidity shortages but the situation has improved considerably since December 2008. However, East Asian financial sectors have largely weathered the crisis. The relative resilience of regional banking and financial systems in East Asia reflects a number of factors, including:2 (i) the very limited direct exposure of the region to subprime and other related securitized products; (ii) relatively strong bank balance sheets with a return to profitability—as impaired loans from the 1997/98 Asian financial crisis have been worked off; (iii) improvements in risk and liquidity management; (iv) strengthening of supervisory and regulatory systems; and (v) moves by banks into new and profitable domestic business lines such as consumer lending. The move into consumer lending implies an absence of the strong search for yield that led many banks and other financial institutions in industrialized countries to take on too much leverage and risk. These factors largely reflect the Philippine situation.3 Crucial prudential indicators show 2
In terms of international trade, prices of traded commodities are mostly set in the global market. Exchange rate movements,
This paragraph is lifted from ADB (2008), page 46. This can be gleaned from a presentation of the Bangko Sentral ng Pilipinas (BSP) entitled “Managing Current Risks and Concerns Facing the Philippine Economy: The Role of the BSP� November 19, 2008. 3
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Table 3: Selected prudential indicators for the Philippines 2000-04
2005
2006
2007
2008
Average Private Sector Loans to Deposit Ratio
63.3
53.7
48.8
49.2
n.a.
Nonperforming loans (% of commercial bank loans)
15.4
8.2
5.7
4.4
3.8 a
Risk-weighted Capital Adequacy Ratios
17.0
17.7
18.5
15.9
15.5b
Rate of Return on Commercial Bank Assets
0.8
1.1
1.3
1.4
1.2 b
Rate of Return on Commercial Bank Equity
5.8
9.5
11.5
11.8
10.6b
Notes: a) as of October 2008 ; b) as of June 2008; ‘n.a’- not availableSource: ADB (2008), pages 5759; data revised and updated by Office of Regional Economic Integration
the relative health of the banking systems in terms of capital adequacy, profitability, and liquidity cushions (Table 3). Loan to deposit ratios have been rather conservative and many banks report high ratios of short-term assets to liabilities. The ratio of nonperforming loans (NPLs) to total loans has continued to decline through 2008. Meanwhile, the key measure of capital adequacy has been sustained at relatively high levels although it has been declining during the past three years. Through the first three quarters of 2008, most banks continued to report relatively high rates of return on assets and equity, and did not experience increases in impaired assets. This performance reflects the insignificant exposure of Philippine banks to the toxic structured mortgage products that were extensively sold globally. Given largely domestically focused business and relatively strong economic activities in 2007, profitability of Philippine banks has generally remained high in 2008.4 Undoubtedly, the Philippine financial sector remains vulnerable to further shocks that emanate from global financial centers. Still, there has been no meltdown similar to the events of 1997. The resilience of the Asian financial sectors stems from policies that are more prudent and a more conservative approach by the banking system.5 In addition, while it would be difficult to establish which factor has been more important, it would
4
The analysis of the Philippine financial sector is based on the analysis provided by ADB (2008) for the East Asia region. 5 A case of “once burned, twice shy.”
nevertheless be safe to say that policies implemented in the aftermath of the 1997 crisis did play a role in limiting the impact of the 2008 global liquidity crunch. The BSP, however, must remain vigilant and implement measures to maintain stability of the financial sectors. Impact on the real sector Production and demand As mentioned earlier, the slowdown of the Philippine economy in 2008 was largely due to a sharp rise in inflation. Another important factor was the pronounced deceleration in construction activity following a surge related to the 2007 elections and the initial implementation of President MacapagalArroyo’s ambitious infrastructure program. Data in Table 1 show that value added in construction grew by only 8.2 percent in 2008 after expanding by 19.5 percent in the previous year. Other production sectors recorded significant slowdowns, particularly in services. The transport, communications and storage sector, which is sensitive to the oil price, and retail trade, which was buffeted by higher inflation, had their growth rates cut by more than half. The financial sector reeled from the global financial turmoil that began as early as August 2007 when the US subprime mortgage crisis broke out. After four years of double digit growth, value added in the finance sector grew by only 4.9 percent in 2008. Surprisingly, the manufacturing sector experienced higher growth in 2008 but this was largely due to food manufacturing. The latter expanded by 8.9 percent in 2008. Meanwhile, electrical machinery—which mea-
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January - February 2009
sures the domestic value added of electronics exports—contracted by 9.2 percent during the same period. This is reflected in a contraction in exports and a slowdown in import growth to only 2 percent in 2008 (Table 1). The electronics sector is where the US recession has clearly manifested itself.
These groups comprise only about 15 percent of the roughly 4 million OFWs. Preliminary data from the Philippine Overseas Employment Administration (POEA) indicate that during the first ten months of 2008, the number of Filipinos deployed abroad rose considerably by 25.5 percent to 1,115,199, from 888,339 a year ago.
The manufacturing sector was aided by the depreciation of the peso after the first quarter of 2008. The strengthening of the peso in 2007 vis-à-vis the US dollar contributed to a lackluster growth rate of 3.4 percent at a time when the economy expanded by 7.3 percent. Growth in the manufacturing sector further slowed to 2.3 percent in the first quarter of 2008. Thereafter, a weaker peso afforded protection to domestic manufacturers from imports, especially those that are artificially cheap.
Data, however, indicate a slowdown in the growth of remittances to only 3.3 percent in October 2008. This brought the cumulative ten-month growth to 15.5 percent, lower than the 16.2 percent average in the first half of 2008. For 2009, the Bangko Sentral ng Pilipinas (BSP) sees a sustained growth in overseas remittances, although at a slower pace of 6–10 percent. This will definitely have a negative impact on the real sector, particularly on personal consumption expenditures. The impact will likely be muted, however, given that it is a 10 percent growth rate for an item that is 10 percent of GDP, the impact would still be substantial.
Meanwhile, growth rate of personal consumption expenditures and fixed investment fell, owing to the overall economic uncertainty. Higher inflation curtailed consumption spending. Private investment continued to remain sluggish despite pump-priming efforts by the government. The external shocks clearly magnified the structural constraints to investment. Employment Critical to the prognosis in 2009 is the impact of the recession in major economies on the employment of overseas Filipino workers (OFWs). Remittances have been the lifeblood of the economy during the past decade. In 2007 alone, remittances—as reported in the balance-of-payments account— amounted to $13.3 billion or 9.4 percent of GDP. The Department of Labor and Employment (DOLE) identified the following OFWs who are vulnerable to displacement due to the global economic and financial crisis: · OFWs who work in the US under temporary working visas (129,000) · Seafarers in cruise ships (130,000) · Factory workers in Korea, Taiwan, and Macau (268,000) · Household service workers in Singapore, Macau, and Hong Kong (48,000)
Employment in the domestic economy has been fairly steady. While the unemployment rate in 2008 increased as expected, the October survey showed a rise to only 6.8 percent from 6.3 percent in 2007. This is still much lower than the unemployment rates recorded during the past 20 years. Assuming that the economy will not decelerate sharply in 2009, there is reason to be cautiously optimistic that the unemployment rate will not rise beyond 7.0 percent in the next 12 months. What should be of concern is that the increase in the number of unemployed came mostly from the manufacturing sector despite the rise in its 2008 growth rate of value added. One reason for this counter-intuitive result is that growth was concentrated in the food, beverage, and tobacco sector. The latter accounts for 53 percent of manufacturing value added but only 25 percent of employment. In contrast, electrical machinery accounts for 8.6 percent of value added and 9.5 percent of employment. This indicates that the economic slowdown has more acute employment effects in specific sectors. For example, it was reported that plant and machine op-
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DEVELOPMENT RESEARCH NEWS erators and assemblers lost 250,000 jobs. Hence, there should be a sector specific dimension to policy responses in addition to the usual economy-wide assistance to laborers. Prospects for 2009 The global environment Global economic growth in 2009 is forecast to fall sharply to only half a percentage point, from 3.4 percent last year (Table 4). The forecast in November 2008 was 1.75 percent, indicating that the situation has been deteriorating relative to initial expectations. Combined output in advanced economies is expected to contract on an annual basis for the first time in the post-war period. Depressed consumption and investment are the main drivers of the economic slump. The collapse of the housing market and fall in equity prices have pulled down the wealthincome ratio in the US, resulting in a sharp reduction in consumption. Meanwhile, the Eurozone was adversely affected by the surge in inflation and direct links to the US financial debacle. Higher prices led to a fall in real incomes that resulted in less consumer spending. In Japan, a stronger yen and the US recession contributed to a decline in exports. This does not augur well for an economy where consumer and investor sentiment have been fragile over the past two decades. Global economic growth is expected to recover in 2010. Judging from the forecasts for advanced economies, the stimulus in 2010 is expected to emanate from emerging markets. However, this largely depends on several factors: a) the success of bailout packages in the advanced economies in reversing the financial meltdown; b) the ability of governments in emerging markets to boost domestic demand; and c) the progress of decoupling between emerging markets and advanced economies. The domestic economy should perform better than expected GDP growth in the Philippines will likely be lower in 2009. The critical issue is the extent of the slowdown. Several multilateral institutions have predicted GDP growth to be below 4 percent (Table 5). However, this largely
January - February 2009
Table 4. GDP growth for major industrialized countries and regions
World US Japan Euro Zone
2007
2008
2009f
2010f
5.2 2.0 2.4 2.6
3.4 1.1 -0.3 1.0
0.5 -1.6 -2.6 -2.0
3.4 1.6 0.6 0.2
Note: GDP calculated based on purchasing-power-parity weights; f – forecast Source: IMF World Economic Outlook Update, January 28, 2009. Downloaded fromhttp://www.imf.org/external/pubs/ft/weo/2009/update/ 01/index.htm
Table 5. Predicted GDP growth rates in 2008 and 2009 (in percent)
World Bank IMF Asian Development Bank
2008 estimate
2009 forecast
4.0 4.4 4.5
3.0 2.25 3.5
Note: GDP growth rate in 2008 was 4.5 percent Source: World Bank (2008); http://www.imf.org/external/np/tr/2009/ tr020209.htm; ADB Asian Economic Monitor, December 2008
depends on the strength of various contending factors. On the one hand, food and fuel prices have come down sharply from their peaks earlier this year. The price of Brent Crude Oil, for example, has already fallen to US$46 per barrel6 from its peak of US$145. Inflation is therefore expected to be much lower in 2009. On the other hand, the synchronized recession in major economies and the global credit squeeze will adversely affect exports, foreign direct investment (FDI), and domestic private investment. Ironically, resilience of the Philippine economy would be partly due to factors that limited its economic expansion during the past 3–4 decades. One aspect is the low value added of Philippine exports in terms of their contribution to GDP. Moreover, the share of Philippine exports to the US has fallen from a peak of 34 percent in 1998 to only 16 percent in 2008. Another factor is the role of FDI in the Philippines where it has not been a source of economic growth in the same degree as some of its neighbors in East Asia. On the domes-
6
As of February 6, 2009.
DEVELOPMENT RESEARCH NEWS
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tic front, it was mentioned earlier that total private investment had been sluggish for the past decade and there is little room for further deterioration.7 The analysis therefore points to a more resilient economy than can withstand external shocks. The performance in the fourth quarter of 2008 augurs well for a 2009 GDP growth of at least 4 percent. Inflation will average between 4.8 and 5.3 percent, still higher than the BSP target. The need for lower interest rates in order to provide liquidity and government pump priming will limit the policy space of the BSP. GDP growth is projected to be 4.3 percent in 2009. The forecast largely depends on stable inflow of remittances that will support a consumption growth rate of 4.5 percent; steady growth in the services sector that will benefit from lower inflation and fuel prices; a boost from public construction activity; and a contained slowdown in the manufacturing sector. These conditions are fairly reasonable and even if external conditions deteriorate further, GDP growth in 2009 is not likely to fall below 4 percent. However, this prognosis should not be a reason for satisfaction on the part of policymakers. The Philippines has one of the worst records in terms of poverty alleviation in East Asia and one major reason is that it has not yet hurdled the low-equilibrium growth trap. Moreover, if the global recovery does not materialize in 2010, the Philippines will be hard pressed to implement countercyclical policies without sacrificing macroeconomic stability. By then, fiscal resources would be severely limited and much attention will be on the 2010 presidential elections. The present administration should therefore take advantage of the current crisis to implement overdue structural reforms. Policy responses to the global economic crisis Policy responses to the global crisis have a
7 A recent World Bank study explains the dilemma of rising economic growth and declining investment. See A. M. Bocchi (2008): “Rising growth, declining investment: the puzzle of the Philippines.� Policy Research Working Paper No. 4472. East Asia and Pacific Region. World Bank.
January - February 2009 basic objective: to break the vicious cycle that has the financial and real sectors feeding on each other in a downward spiral. The debacle in the banking sector has constrained credit that limits domestic demand, which then leads to lower profits and difficulty in loan repayments. In countries where the financial sector has not been severely affected like the Philippines, the objective is to offset the effects of lower exports and domestic demand before a contraction in output leads to the vicious cycle. The Philippine government responded to the surge in inflation and later to the global financial crisis. To mitigate the adverse impact of rising prices, the government expanded and strengthened various social protection programs. However, many of these programs suffer from several drawbacks (Manasan and Cuenca, 2007; ADB, 2007). The Philippines has a wide range of social protection programs, many of which are hindered by low coverage and inadequate benefits, poor targeting, and operational constraints due to lack of coordination among program implementers. Low coverage and low level of benefits stem from lack of funding. The persistent budget deficits incurred through the years and over reliance on foreign grants meant lower government spending on social services and higher risk of program discontinuation. Lack of funding support is exacerbated by poor targeting which causes leakage and wastage of resources on the non-poor and the near poor. Furthermore, social protection programs, in most cases, are implemented on a piece-meal basis, due in large part to the differing mandates of program implementers. As a result, overlaps and redundancies in sectoral and geographical beneficiaries abound, causing additional strain on scarce resources. It would be useful for the government to address the shortcomings of these programs because they can play an integral role in addressing the possible economic slowdown in 2009.8
8
This evaluation is largely based on ADB (2007).
DEVELOPMENT RESEARCH NEWS Policymakers have also identified fiscal strategies to offset the possible economic downturn. The Department of Finance formulated a fiscal stimulus plan that involves an increase in the capital outlay in 2009 amounting to P275 billion or 3.3 percent of GDP. This is higher than the amount in 2008 which was P217 billion or 2.9 percent of GDP. The government has also widened its deficit target for 2009 to allow for increased spending. The budget deficit goal was reset to 1.2 percent of GDP from an original plan of 0.5 percent for next year. Subsequently, the fiscal stimulus plan was announced as a P300 billion package that would prioritize “easy to implement projects” like repair and rehabilitation of roads, hospitals, bridges and irrigation facilities, and school and government buildings. To ensure that the stimulus packages or plans will achieve their objective of generating demand and jobs in the domestic economy, the World Bank (2008) advised that they be well targeted toward programs and investments that employ the most people, alleviate supply constraints, and are focused in areas that are likely to be hardest hit by the slowdown. Such countercyclical fiscal policies could perhaps start with the protection of infrastructure programs and the expansion of targeted social safety nets that can also serve as an automatic stabilizer. It is in this context that evaluating and redesigning social protection programs becomes important. Meanwhile, Philippine economic managers have implemented a set of policies to ensure stability of the financial system. For example, the BSP opened a US dollar repurchase agreement or repo facility to augment dollar liquidity in the foreign exchange market and ensure the ready availability of credit for imports and other qualified funding instruments. In addition, the BSP recently approved guidelines allowing financial institutions to reclassify financial assets from categories measured at fair value to those measured at amortized cost. The latter measure eased the pressure on the balance sheets of financial institutions. The most recent measure was a half-percentage point cut in policy rates on December
9 18, 2008 and January 29, 2009 aimed at easing credit and protecting economic growth. This followed the US Federal Reserve’s unprecedented move to lower its target for the interbank federal funds rate to a range of zero to 0.25 percent from 1 percent. These measures indicate that Philippine policymakers have heeded the advice to be proactive rather than reactive, and to forestall emerging threats to financial stability. The measures are largely in line with the three sets of short-term policy responses the ADB (2008) identified that are needed to bolster the foundations of financial stability: · Close monitoring of the region’s financial systems and the identification of both weak financial institutions and systemic vulnerabilities; · Provision of adequate foreign currency as well as domestic liquidity to systemically critical financial institutions so that credit continues to flow into the economy; and · Prevention of the effects of slowing economic growth from spilling over onto the region’s banking systems. In the medium term, policies anchored on regional cooperation will take center stage. This will run parallel with efforts to reform the international financial architecture. There have been many initiatives in the area of regional economic cooperation and integration, particularly in East Asia. However, these will take on a sense of urgency in the context of the crisis. The main objective would be to strengthen intraregional trade and investment to reduce dependence on the industrialized economies of the West. Meanwhile, regional financial cooperation should be restructured and reoriented in order to support this objective and protect the region more effectively against the vagaries of the global financial system. Various policy recommendations are presented in Box 1. References Asian Development Bank. 2008. Asia Economic Monitor.
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Asian Development Bank. 2007. Philippines: Critical development constraints. Economics and Research Department, Asian Development Bank, Mandaluyong City. Manasan, R.G. and J.S. Cuenca. 2007. Who benefits from the Food-for-School Program and Tindahan Natin program?: Lessons in targeting. PIDS Discussion Paper 200710. Available at http://dirp4.pids.gov.ph/ ris/dps/pidsdps0710.pdf. World Bank. 2008. East Asia: Navigating the
January - February 2009
perfect storm. East Asia Pacific Update. Yap, J.T. 2008a. What’s in store for the Philippine economy in 2008? PIDS Development Research News Vol. XXVI No. 1. Available at http://dirp4.pids.gov.ph/ ris/drn/pidsdrn08-1.pdf. Yap, J.T. 2008b. Regional cooperation in East Asia amid global economic turmoil. PIDS Policy Notes 2008-04. Available at http:// d i r p 4 . p i d s . g o v. p h / r i s / p n / pidspn0804.pdf.
Box 1. Regional and longer-term responses to the 2008 economic crisis
T
he region should continue to work for progress in the multilateral trading system. This is the first best defense against the possible rise in protectionism. Working for the success of the Doha Development Round can be a good start. There is room for lowering the wide margins between MFN tariffs and bound rates for agricultural products in Asia and increasing the binding coverage for all goods. The improvement in these policy parameters will introduce more transparency into Asia’s tariff regime. Largely forgotten is that the first best policy is not multilateral liberalization but unilateral. While this is an unattractive policy at present, one clear policy response in Asia is to continue with its regional liberalization which has been largely consistent with multilateral liberalization. There is a growing consensus that Asia‘s export strategy needs to be reexamined. A shift to domestic-led growth would be beneficial in the medium term in order for the region to move toward a more balanced growth. However, many countries are constrained by their small domestic markets and fragile fiscal positions, therefore they have limited degrees of freedom to pursue expansionary policy that can easily translate to inflationary pressures in an environment of depreciating currencies. Given the constraints of domestic led growth, the region should diversify its export destinations and/or diversify its export product mix. Asia has not yet fully tapped the new emerging
markets of Brazil and Chile, as Asia’s trade with Latin America is only 2.5 percent. Another avenue is expanding intraregional investment, particularly in infrastructure projects. Regional cooperation in East Asia can promote the development of domestic financial markets and regional financial integration in order to facilitate the intermediation of Asian savings within the region as well as attract foreign investment in instruments denominated in the domestic currency. Such alternative sources of funding would reduce Asia’s reliance on foreign currency borrowing and concomitantly, the risk exposure of the region to maturity and currency mismatches. This type of regional financial cooperation has already been initiated in the form of the Asian Bond Markets Initiative (ABMI) which was endorsed by the ASEAN+3 finance ministers in August 2003 and the Asian Bond Fund (ABF) initiative which was launched by the Executives’ Meeting of East AsiaPacific Central Banks (EMEAP) in June 2003. However, the ABMI and ABF initiatives consider only the financial side of the issue. Regional cooperation can also be useful in identifying infrastructure projects to be funded. Recently, the Network of East Asian Think Tanks (NEAT) proposed the establishment of the Asia Investment Infrastructure Fund, which is a mechanism by which infrastructure projects in the region can be prioritized and funded. By considering
DEVELOPMENT RESEARCH NEWS
the “real� side of the issue, more substance will be given to regional financial cooperation. Of course, the structure and configuration of the Asia Investment Infrastructure Fund still has to be threshed out, particularly on how it will relate to the Asian Development Bank. A broader agenda for regional cooperation is addressing weaknesses in the global financial system in order to improve its functioning and integrity. Measures in these areas can be usefully coordinated regionally along with initiatives from the G-20, the Financial Stability Forum, and the International Monetary Fund (IMF) in calling for detailed work programs on crisis prevention and crisis management. Based on the experience of addressing the Asian financial crisis as well as its spillovers, the region has a strong interest in contributing to the work programs and ensuring that financial systems will become less prone to crisis. Identifying reforms in the international financial architecture will enable various regional forums to coalesce common interests and project them in a global rules setting. This is a way by which regional financial cooperation can be sustained without expending a great deal of political capital. A logical outcome of this process is the identification of areas where regional and national reforms can support the global effort. ADB (2008) has provided a useful summary of the main issues at the international, regional, and national levels: Strengthening transparency and accountability Special attention needs to be paid to measures that would strengthen financial system transparency. This is in response to the problem associated with the opaqueness of complex derivative products and the lack of clarity on who holds the risks. Accordingly, disclosure of complex financial products and of the financial conditions of firms should be emphasized. Enhancing sound regulation and prudential oversight
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January - February 2009
Weaknesses and gaps in financial sector regulation and supervision arguably allowed excessive leverage and risk taking, and the buildup of significant off–balance sheet leverage in Special Investment Vehicles and other conduits. Accordingly, strengthening and broadening regulation and oversight can help address those features of regulatory regimes that may have contributed to the current turmoil. Regulators need to strike an appropriate balance between competing objectives such as fostering financial innovation and maintaining financial stability. In doing so, however, they need to resolve issues regarding regulatory gaps and ensure that all financial institutions and markets are subject to “appropriate� supervision or oversight. Mitigating procyclicality of financial systems Regulators should consider designing prudential regulation in a countercyclical fashion, including forward-looking risk evaluation and adequate liquidity provisioning to help avoid large financial swings and their destabilizing effects on the economy. Currently, most financial systems exhibit a high degree of procyclicality. For example, as a result of variations in specific provisioning and changes in perceived risk, the Basel II framework may lead to a situation where the amount of capital banks are required to hold declines during business cycle expansions and increases during contractions. Particularly in emerging market economies, excessive risk taking during booms— associated with large capital inflows and rapid domestic credit growth—is often the origin of a financial crisis. Maturity and currency mismatches on financial and nonfinancial balance sheets during booms also add severe strain on currencies and financial systems. Effective risk analysis by financial institutions, together with countercyclical and forward-looking prudential provisioning, will therefore help sustain financial stability through the down cycle.
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Reinforcing international cooperation in regulation Asian economies should strengthen the existing ASEAN+3 framework by sharing more information, harmonizing prudential indicators, increasing coordination on the conduct of early warning system analysis, and discussing more openly national and regional policy interventions. And as discussed earlier, to help monitor potential financial vulnerabilities and to develop a plan of action in response to the immediate challenges of a financial crisis with the help of the private sector, an “Asian Financial Stability Dialogue” among ministries of finance, central banks as well as market regulators and supervisors can be created. Broadening and deepening financial markets to enhance resilience Broadening and deepening financial markets—in particular local currency bond markets—remains an important long-term goal for more efficient and resilient domestic
financial systems. The development of liquid and well-functioning local currency bond markets offers an alternative financing source to bank loans, provides long-term domestic currency funding for investment, and helps foster regional financial stability. A broad range of reforms is required to develop well-integrated and functioning Asian bond markets. This includes: (i) improving the legal and regulatory frameworks to ensure transparency and investor protection; (ii) removing impediments to market entry and investment, particularly those on capital and exchange controls; (iii) broadening and diversifying the investor base; (iv) strengthening capacity of regulators; and (v) improving related infrastructure such as clearing and settlement, credit guarantee, and data collection. At the regional level, for instance, the new medium-term roadmap under the Asia Bond Markets Initiative aims to address many of these issues. DRN