Vol. XVII No. 3
T
he worst part of the East Asian financial crisis seems to be over. Two years after the crisis struck, every affected country is picking up the scattered pieces and analyzing just where economic management went wrong. What really caused the crisis? Were the reasons the same for all Asian countries? How do we know when such a crisis is coming? Regardless of what the real cause(s) of the recent Asian financial crisis is(are), it is worthy to note that a number of economic reforms have since been put in place in most of the countries affected. The banking sector reforms within said countries and, more recently, the efforts to look into possible reforms in the international financial system, for instance, are positive outcomes that have somewhat resulted from the crisis.
WHAT'S INSIDE 4 - 5 The Corporate News * The Research Planning Workshop: Toward a More Responsive Research Program * VOW: Reinforcing Individual and Organizational Values
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Post-MWSS Privatization Water Supply Situation in Metro Manila: Is There an Improvement?
May - June 1999
ISSN 0115-9097
Outsmarting Another Crisis: An Early Warning System for the Philippines Still, against such backdrop is the need to monitor short-term fluctuations of key economic variables in order to anticipate currency or balance-of-payments (BOP) crisis in the future. Dr. Josef T. Yap, senior research fellow at the Philippine Institute for Development Studies (PIDS), concurs with this statement in his Discussion Paper No. 98-40 entitled “Developing an Early Warning System for BOP and Financial Crisis: The Case of the
Philippines” where he proposes the development of an early warning system (EWS) that may signal an impending crisis. Adopting the Kaminsky-Reinhart framework (1996) and using Philippine data in its application, Yap noted that the basic idea of the EWS is to monitor key economic variables which would enable policymakers to predict a crisis, allowing them sufficient time to implement the appropriate measures to stem the crisis or at the very least minimize its adverse impact.
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EDITOR'S NOTES Being forewarned is forearmed. When the financial crisis hit Asia in 1997, a good number of Asian countries were caught "sleeping" in the middle of the night. They awoke to a troubled economy and a bewildered citizenry. But since reform measures have been put in place in most of these countries, it is expected that any future crisis (although none would want such a thing to happen again) will not be as serious as that of 1997. For this issue, we are including Dr. Josef Yap’s paper on how the Philippines —and
the rest of the Asian countries— can predict future financial crises using a set of economic indicators called the Early Warning System (EWS). Based on the frequency and level of noise or signals emitted by these indicators, economic managers may be forewarned of an impending crisis in the finance or banking sectors. Find out more if the EWS can be depended upon to do the job. The other topic featured in this issue refers to the privatization of the distribution function of the Philippines' water system and
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DEVELOPMENT RESEARCH NEWS
He added that through a careful look at the behavior of specific economic variables on a per country basis, the system can also help shed light on the debate regarding the root causes of the recent East Asian financial crisis, that is, whether the countries involved had weak economic fundamentals or whether there was a self-fulfilling crisis brought about by panic among investors. If the signals are shown to have been flashing prior to September 1997, then the crisis may indeed be attributed to weak economic fundamentals. If, on the other hand, no signals were being displayed, then the crisis could have very well been brought about by contagion and panic on the part of foreign investors.
First, identify the sample of countries to be evaluated. While it is possible to base the analysis on just one country, the limited number of crises will prevent a solid generalization on the usefulness of the indicators.
Monitoring Economic Indicators
Table 1: Leading Indicators
What economic indicators should be monitored? And how? Yap identified two prominent methodological categories as the basis for classifying monitors. The first one is the probability approach which estimates the probability of a devaluation based on regression estimates. However, these indicators are not appropriately ranked according to their ability to accurately predict the occurrence of a crisis. It does not even produce a clear reading of where and how widespread the macroeconomic problems are nor does it provide a longterm and accurate forecast. The second, called the signals approach, addresses the weaknesses of the first approach and is the one adopted by Yap (see Table 1 for the list of leading indicators proposed to be monitored in the use of the warning system).
Constructing the EWS The following represents the step-by-step procedure in the construction of such system using the signals approach:
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Second, define crisis. Some economists, for example, declare bank crisis in terms of bank runs, closures, mergers, and others. For a currency crisis, it might be reflected in a weighted average of changes in nominal exchange rates and changes in international reserves. When readings of three or more standard deviations above the mean are shown, then it’s regarded as a currency crisis.
Third, define the term “early.” For currency crises, early may range from one to 24 months. For banking crises, it may range from one to 12 months before the start of a crisis or even 12 months after such crisis. An “early” period may vary from one country to another. Fourth, pick out a list of potential early warning indicators to be monitored based on economic theories, past empirical works and the availability of high frequency data. Fifth, find the optimal threshold for each indicator that will accurately signal the start of a forthcoming crisis.
Financial Sector M2 multiplier A higher multiplier indicates higher growth in money supply which may lead to higher inflationary expectations and expectations of a future devaluation of the currency. Domestic credit A larger amount of credit increases the chances of bad loans and bank failures. Higher credit also implies a larger amount of money supply. In the absence of data on domestic credit, the growth of M2 in real terms was used instead. M2/Reserves Economic agents fearing a devaluation may substitute local currency for foreign currency. The M2/Reserves ratio is an indication of the extent to which the Central Bank can withstand this pressure. Lending/Deposit rate A higher spread indicates that the Central Bank is increasing interest rates to stem credit growth. Higher lending rates increase the chances of bad loans. Deposits A decline in the deposit base increases the chances of a bank run. Real interest rate Higher interest rates increase the probability of loan defaults. Excess money balances This is related to the M2 multiplier and domestic credit variable. Excess money balances reflect excess money supply which puts pressure on the exchange rate. The difference in the growth of M1 and the production index was used as an indicator in this study. [continued]
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value of the index. An indicator is good when, in cases where its value crosses the threshold, a currency crisis occurs within 24 months or a banking crisis occurs within 12 months.
Table 1 (Continued) External Sector Exports Lower export growth may signal problems with the trade balance. Imports Higher import growth may signal problems with the trade balance. Interest rate differential This is defined to be domestic interest rates less foreign interest rates as measured by the 90-day US Treasury Bill rate. The lower the differential, the larger is the probability of an outflow of reserves. Real exchange rate Two versions could be used. One is the simple year-on-year rate of growth to indicate an appreciation or depreciation. Excessive appreciation was used as an indicator of currency overvaluation which may eventually lead to problems in the trade balance. Another version based on Kaminsky and Reinhart was to estimate the deviation from trend. The trend values were taken to be the equilibrium value.The first version was used in this study. Reserves This is the classic indicator based on Krugman’s seminal paper on BOP crises. A low level of reserves —below a critical threshold— may trigger a speculative attack against the currency. Real Sector Output growth Lower output growth indicates a deceleration of the economy prior to a crisis. A modification to this would be to take the first difference of output growth to reflect more accurately an economic decelaration. The value index of manufacturing output was used and this was deflated by the CPI to obtain an index in real terms. Stock market prices A decline in the growth rate of asset prices may lead to loan defaults. It also signals a loss of investor confidence. This index was not included because of lack of data prior to 1987. [Note that variables from the external sector can be leading indicators of a banking crisis because of the relationship between a BOP and a banking crisis.]
In other words, the point at which the behavior of the indicator signals a crisis must be set. The optimal threshold will generally be different for each indicator; between a banking and a currency crisis; and even from one country to another.
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Sixth and last, identify the countries and time periods where the probability of a crisis was higher than elsewhere or at other times. This can be done by using a composite index and computing for the probability of a crisis within a specific time given the
Compressing the indicators into one composite index can further facilitate the analysis and estimation of a forthcoming crisis. The first composite index, labelled S, is a simple count of the flashing signals. However, it does not take into account the different forecasting accuracy of each variable. The second composite index, K, weighs the signals of different variables by the inverse of their noiseto-signal ratio. The third composite indicator, labelled W, accounts for the intensity of the signal of each univariate indicator.
The Philippine Application The system is expected to equip policymakers with enough information to determine when the economy becomes fragile. In the case of the Philippines, the signals approach was applied for the period January 1981 to December 1997. There were two currency crises identified within said period: October 1983 and September 1997. In 1983, three indicators — ranked according to the number of signals they emitted— were constantly flashing during a period defined as “early,” namely: total foreign exchange reserves; the ratio of M2 to total reserves; and the interest rate differential. In 1997, the most active indicators were the real effective exchange rate, excess M1 balances, and the real growth of M2. These indicators, though, were not consistently flashing two years before the crisis. This implies that the source of the crisis for the two abovementioned periods was different.
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DEVELOPMENT RESEARCH NEWS
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May - June 1999
The
CORPORATE NEWS
The Corporate News section includes brief accounts of inhouse PIDS activities, staff training and workshop results. The idea for the inclusion of this section is to let our readers know what is happening inside the Institute. That behind the pages of the Institute’s various research outputs and analyses are stories about departmental staffs, work groups and individuals getting together to plan the next set of programs, striving to further improve their knowledge or skills through trainings, and/or interacting with one another to promote better teamwork. Most of the time, the stories focus on serious stuff. On certain occasions, though, they simply talk about the PIDS staff having fun. Whatever the topic is about, however, the objective is to show that it is meant to help the staff become better persons and performers in their respective fields so that they can contribute more to the attainment of the Institute's overall mandate.
The Research Planning Workshop: Toward a More Responsive Research Program by Mari-Len R. Macasaquit
It has been argued that one tends to think better under a
more relaxed and informal atmosphere. With this in mind, the Philippine Institute for Development Studies (PIDS) chose to hold its planning workshop on the formulation of its research program for the new millennium in an island resort away from the hustle and bustle of Metro Manila. The three-day workshop brought together the Institute’s research staff —from the Senior Research Fellows to the Associates and Assistants to the support staff— to brainstorm, plan, reingineer, and reestablish new program areas for the period 2000 to 2004. The ultimate objective was to come up with a research agenda that is more responsive to the country’s requisites for development and reflective of the demands and needs of the Institute’s publics. During the workshop, each of the Fellows presented his/ her proposed research themes/program areas for the next five years. These inputs were to become an integral part of a broader research agenda to be sifted and refined by two consultants, Let's start the ball rolling. Dr. Mario Lamberte (Acting President) and Dr. Gonzalo Jurado (Visiting Senior Research Fellow) led the discussions in the research planning workshop.
Dr. Cielito Habito, former National Economic and Development Authority Director-General, and Mr. Margarito Teves, chairman of the research organization, Think Tank, Inc., and former member of the Philippine House of Representatives. The proposed research themes and program areas identified by the PIDS research staff essentially reflected their visions of the Philippine economy within an international environment as well as their expectations of the emerging policy issues. PIDS Acting President, Dr. Mario Lamberte, and Visiting Senior Research Fellow, Dr. Gonzalo Jurado, jointly presided over the workshop discussions. Dr. Lamberte also provided the framework for discussion. He first asked each Fellow to present his/her vision for the country in the 21st century to provide the direction by which he/she will follow and focus on with regard to specific policy areas. He then moved on to the second part of the framework which centered on the Fellows’ key assumptions of the overall scenario that would serve as their guide for determining their own set of priority policy areas. Dr. Lamberte likewise enumerated his key assumptions which more or less reflected the economic agenda set by the present Estrada administration. He mentioned that it was expected that the integration of the Philippine economy with the rest of the world will continue, that the policies already implemented will be maintained, and that the local government units (LGUs) would increasingly participate in planning and policy formulation. Dr. Lamberte likewise bared his plans to have a more formal mechanism of policy monitoring and evaluation. He said that each year, the Institute must have a running total of policies that have been put in place, with an analysis of the consistency of the implemented policies vis-à-vis the original policies. The consensus was that the Institute would focus and give priority to the the following program areas for the next five years: (1) industry, agriculture and services; (2) resource mobilization; (3) human resource development, income distribution and poverty; (4) competition policy and corporate governance; (5) decentralization and subnational governance; and, (6) policy analysis and planning tools and monitoring systems. Each major program area is composed of several policy components.
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DEVELOPMENT RESEARCH NEWS
VOW: Reinforcing Individual and Organizational Values
Last summer, a total of 61 PIDS employees, divided into two
The workshop is part of the Values Development Program of the Civil Service Commission (CSC) which includes courses “designed to enhance and harness the public service values”
May - June 1999
of participating government workers to make them more competent and inculcate in them appropriate norms and conduct. Participants in the first workshop were one in saying that they had an exciting and stimulating workshop, contrary to their initial expectation. With the CSC’s new training technique and highly motivated pool of facilitators coming from various government organizations, the workshop proved to be a very good “positive values reinforcement” tool for members of the bureaucracy. Because of the good feedback, the second VOW activity was very much anticipated.
The VOW focused on four areas of an individual, namely, his personhood (pagkatao),his consciousness of the environment (pagkakalikasan), his sense of service to the public (pagkatagapaglingkod), and his sense of national identity (pagka-Filipino). These areas were examined and scrutinized with the purpose of clarifying the participants’ existing values, expressing
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CORPORAT E NEWS
Facilitators in the April workshop included Ms. Regina Uy Selomandin, a training specialist at the Human Resource Development Bureau of the Department of Social Welfare United we dance. They dared to show their stuff in the name of unity. From left: Marc Macariola, and Development, Mr. Nile Anne Cleofas, Millet Belizario, Laila Garcia, Merle Galvan, Eden Villanueva and Al Pasion. Tiburan, a training officer and clinical coordinator at the Training and Research Office of the Jose R. Reyes Memorial Medical Center, and Ms. Lu Zervoulakos, chief of the Human Resource Management Services of the Philippine Atmospheric Geophysical Aeronautics Administration. The May workshop, meanwhile, was facilitated by Ms. Soledad Tioseco, officer-in-charge of We made it! The second batch of participants with (seated from left) Ms. Ula Tioseco (facilitator), Ms. the Manpower Development and Employee Welfare Rhea Agcaoili (Director, Operations and Finance), Dr. Mario Lamberte (Acting President) and Mr. Mario Feranil (Acting Vice-President). Section of the Senate of the Philippines.
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batches, participated in a Values Orientation Workshop (VOW). The first batch had their VOW at the Development Academy of the Philippines (DAP) Conference Center in Tagaytay City from April 14 to 16, 1999 and the second batch at the National Arts Center in Makiling, Laguna from May 27 to 29, 1999.
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DEVELOPMENT RESEARCH NEWS
Reinforcing...
Outsmarting...
From page 5
From page 3
their commitment to their respective values, and formulating an action plan which would support their commitments.
Using the composite index, major inconsistencies appeared in 1986 and within the period of August 1994 to March 1995. Although strong signals were emitted during these periods, no crisis occurred within 24 months immediately after the period.
The program’s modules followed a specific order such that each participant had to evaluate his relationship with himself first before he assessed his relationships with nature, with the public and with his country. In the first module, the participants were asked the following questions: Who are most important to you? How do you wish to be known to them? How would you feel if they were taken from you? Such intimate questions drew tears from most of the participants who, when faced with virtual loss, realized the importance of the people they held dear. In the second, their connection with the environment was put to test through activities like communing with nature under an evening sky and designing a community or city plan around a specific environmental setting. The facilitators aroused the participants’ sense of public service in the third module as the former introduced the concept of empowerment through the practice of norms of conduct. And finally, the participants were subjected to a lot of soul-searching during the last session as they were exposed to Filipino values, customs and history. The three-day activity utilized the method of adult learning based on the four-stage process of activity, analysis, abstraction and application. In both workshops, the participants were grouped into four teams, allowing them to fully interact with one another to carry out their respective group’s presentation. All in all, the workshops had a revitalizing effect on the employees who experienced a renewal of their values as individuals and as public servants. DRN Adults already possess certain values which just need to be enhanced or reinforced. -VOW Program of the CSC
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During the period prior to the 1997 crisis, the S and W indices were relatively mild while the K index was strong from March to April 1996 and from December 1996 to January 1997. Still, in comparison with the 24 months prior to the 1983 crisis, the signals were rather weak.
Conclusions In a way, the results show that, most probably, the crisis in the Philippines was brought about by the contagion effect interpretation of the 1997 East Asian financial crisis. Many of the economies affected by the 1997 crisis were vulnerable but not to the extent to warrant the occurrence of a crisis and deterioration in their economies. It was likely that the crisis
Editor's Notes...
was exacerbated by panic among the investors. In addition, a more refined list of indicators may be required since the economic structure of the Philippines has changed much since reforms were implemented. Additional indicators from the financial sector are required, and should be tested on other countries as well. The optimal thresholds of indicators also need to be looked into. The threshold might have been lower, thus, the reason for the mild signals emitted by the indicators. In the case of self-fulfilling crises, a regular survey of the sentiments and expectations of economic agents should be monitored. The “early” period should likewise be extended to 36 months before and after the crisis. In conclusion, the early warning system shows some promise but has to be modified. DRN
Reference Kaminsky, G. and C. M. Reinhart. "The Twin Crises: The Causes of Banking and Balance-ofPayments Problems," International Finance Discussion Paper No. 544. Board of Governors of the Federal Reserve System, Washington D.C., March 1996.
From page 1 how this action can help ease the water situation in Metro Manila. The article is based on PIDS Senior Research Fellow Dr. Cristina David’s research paper on said topic. Lastly, the Corporate News highlights two PIDS workshops, namely, the planning workshop of the research department and the values orientation workshop for all employees. The articles emphasize the lessons to be learned from both wokshops and how these can help smoothen work and personal relationships for the benefit of the whole Institute. DRN
The Research... From page 4
The research planning workshop also served as an opportunity to enhance unity and camaraderie among the research and support staffs in both official and personal terms. It likewise helped in making the staff identify and relate better to the roles that each of them must play in order to attain the Institute’s overall objectives. DRN
DEVELOPMENT RESEARCH NEWS
Post-MWSS... From page 8
if concessionaires are compelled to charge the lowest tariff block. In fact, the retention of the increasing block tariff structure in the concession agreement to cross-subsidize the poor proves to be inapplicable as the recent household survey conducted by David and Associates indicates that majority of low-income households in Metro Manila do not even have individual piped water connection or are not at all reached by the MWSS pipe distribution system. Furthermore, households in squatter areas only have few public standpipes, mostly not operational at that, for their water needs. As such, these poor households are forced to buy water which, ironically, turns out to be more expensive than what the middle and higher-income households are paying for their piped water system. The same 1998 survey by David et al. also noted that the price of
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vended water from both MWSS and deepwell sources had increased significantly despite reduction in the average official price of MWSS water. Vended MWSS water costs about P30 to P200 per cu. m. on the average while vended deepwell water costs about P100 to P150 per cubic meter. On the other hand, the Manila Water Company charges only P7.78 for the first 10 cu. m. in the East Zone while Maynilad Water Services, Inc. charges P16.69 for the first 10 cu. m. in the West Zone. Such disparity clearly shows that the poor who depend largely on vended water are doubly penalized in that they not only have an inadequate supply of water but also pay more for the water that they have to buy.
Recommendations Clearly, the adoption of full economic cost pricing policy is a critical step to achieve the overall objective of economic efficiency, social equity and environmental sustainability. This would involve the imposition of a raw water charge on Angat River water, pumping charge for groundwater abstraction and water pollution tax beyond the existing coverage area.
DEVELOPMENT RESEARCH NEWS is a bi-monthly 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: Research Information Staff Philippine Institute for Development Studies Room 304, NEDA sa Makati Building, 106 Amorsolo Street, Legaspi Village, 1229 Makati City, Philippines Telephone numbers 892-4059 and 893-5705 Telefax numbers (632) 893-9589 and 816-1091 E-mail address: publications@pidsnet.pids.gov.ph Re-entered as second class mail at the Makati Central Post Office on April 27, 1987. Annual subscription rates are: P150.00 for local subscribers; and US$20.00 for foreign subscribers. All rates are inclusive of mailing and handling costs. Prices may change without prior notice.
The government revenue from the full economic cost pricing policy may be earmarked for water resource management of the public sector, including the funding of groundwater recharge and watershed protection; water supply and sewerage planning; and the subsidizing of the cost of water, sewerage and sanitation service for poor households. (LPS) DRN
Vol. XVII No. 3
May - June 1999
Editorial Board Dr. Ponciano S. Intal, Jr. President (on leave) Dr. Mario B. Lamberte Vice-President and Acting President Mr. Mario C. Feranil Director for Project Services and Development and Acting Vice-President Ms. Jennifer P.T. Liguton Director for Research Information Ms. Andrea S. Agcaoili Director for Operations and Finance Atty. Roque A. Sorioso Legal Consultant
Staff Jennifer P.T. Liguton Editor-in-Chief Genna J. Estrabon Issue Editor Barbara F. Gualvez, Liza P. Sonico, Corazon P. Desuasido, Jane C. Alcantara, Joel C. Cruz, and Edwin S. Martin Contributing Editors Valentina V. Tolentino and Rossana P. Cleofas Exchange Delia S. Romero, Galicano A. Godes Necita Z. Aquino, Lilet L. Lamayo and Federico D. Ulzame Circulation and Subscription Genna J. Estrabon Layout and Design
DEVELOPMENT RESEARCH NEWS
T
he privatization of the Metro Manila Water and Sewerage System (MWSS) in 1997 was an important positive step towards improving water resource management in the greater Metro Manila area. This is the preliminary assessment of Dr. Cristina David, Senior Research Fellow at the Philippine Institute for Development Studies, in her study entitled Impacts of MWSS Privatization: Implications on Efficiency, the Poor and the Environment. Dr. David noted, however, that realizing the full potential gains from such initial step over the long term depends on the following: * the ability of the Regulatory Office and the residual MWSS to enforce the contractual agreements, anticipate and implement necessary adjustments arising from possible weaknesses in the contract design as well as the technical and financial bids; * the ability of the Regulatory Office and the residual MWSS to adopt a more integrated and holistic approach in dealing with the issues of water supply, sewerage planning and operations, demand management, pollution control, and watershed and groundwater protection; and * the ability of the government to undertake the necessary institutional, regulatory and policy reforms in the water sector. She also emphasized that besides enforcing the contractual agreements and regulating water prices, the regulation and management of the privatized MWSS structure must be evaluated from the overall objective of economic efficiency, welfare of the poor or social equity and environmental sustainability.
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Post-MWSS Privatization
Water Supply Situation in Metro Manila: Is There an Improvement? Implications on the environment On health and water pollution control According to Dr. David, a major potential contribution of the privatization decision toward the control of health and water pollution would be the more organized and expanded efforts in dealing with sewerage and sanitation problems. Efforts in this area had been extremely limited prior to privatization. The Regulatory Office is expected to strictly enforce and monitor drinking water and wastewater standards since there is now a greater incentive to comply. Noncompliance, after all, means breaching the service obligation. Admittedly, however, there are still segments of the population as well as commercial and industrial users which are excluded from such regulation.
Nonetheless, without the MWSS privatization, expansion of sewerage and sanitation services would be more difficult to expect especially in depressed or squatter areas, given limited government resources.
On water conservation and groundwater depletion The imposition of higher sewerage and sanitation charges in water consumption will increase incentives to save water among users of such services. Consequently, with water conservation, pressure on the groundwater resource may be lessened.
Implications on the poor The impact of privatization on the poor depends largely on the adequacy of MWSS water supply. With water supply shortages, the poor would tend to receive low priority, especially
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"...besides enforcing the contractual agreements and regulating water prices, the regulation and management of the privatized MWSS structure must be evaluated from the overall objective of economic efficiency, welfare of the poor or social equity and environmental sustainability."