RP faces uphill climb due to budget gap

The Arroyo administration’s failure to meet its deficit target is not a bump on the road but a warning of an uphill battle that would dampen the near-term outlook in the stock market and delay the recovery of the peso and interest rates for a few more quarters.

The analysis was made by Deutsche Bank, one of the Arroyo administration’s favorite underwriters, which said that the revision of the 2002 and 2003 targets confirmed the negative spin on the first half’s disappointing fiscal performance.

In a paper analyzing the country’s macroeconomic strategy, Deutsche Bank said the early slippage in fiscal performance was "not just a bump on the road to a new era of fiscal discipline but a warning that the journey would be an uphill one."

In the face of a bleak economy, Deutsche Bank said overseas workers would be the country’s source of spending power as remittances increased by 40 percent this year, representing 10 percent of total gross domestic product.

"This is the extent to which the Philippines now piggybacks on more successful economies and the extent to which it has diversified from its own historically unpredictable local economy," Deutsche Bank said.

"Ironically, it is the very bleakness of economic conditions over the past three years that has accelerated the exodus of Philippine labor abroad and improved the outlook for future remittances," Deutsche Bank said.

Deutsche Bank’s comments came shortly before the government sent a team led by top economic officials to meet with foreign investors in an international roadshow that was cosponsored by the bank and other private groups.

According to Deutsche Bank, the government would have to reassure investors that its structural reforms were in place and the administration’s new fiscal timetable still promised a balanced budget by 2006.

With political realities in mind, the Department of Finance has raised next year’s budget deficit target by 47 percent from P90 billion to P142 billion. Deutsche noted that Camacho’s argument was that this would not put pressure on interest rates given the ample liquidity that exists and low private sector appetite for credit.

According to Deutsche Bank, however, this only indicated that the problem would spill over into 2003.

"Whilst we concede that there is ample liquidity around, we believe that the appetite for Philippine risk will be limited unless the emerging credibility issue is properly addressed," Deutsche Bank said. "The markets must be convinced that this latest revision of targets will be the last and there will be no more surprise issuances of Philippine debt paper."

Finance Secretary Jose Isidro Camacho, former Deutsche Bank country manager, has repeatedly contended that next year’s revised deficit still represented a declining percentage of gross domestic production but the Bank said it was doubtful whether the capital markets would take consolation from this argument. "This condition is contingent on the government’s rosy GDP growth forecast being met," Deustche Bank said.

Deutsche Bank said that the budget deficit confirmed what financial markets have feared early on that the disappointing fiscal performance indicated the start of a recurring shortfall in government revenues and a continuing build up of debt.

"To be fair, we think the deficit is more a reflection of weak tax revenues than irresponsibility on the part of the Arroyo government," Deutsche Bank said. According to Deutsche Bank, however, the collection inefficiencies in the "archaic" Bureau of Internal Revenue (BIR) continues to cause a hemorrhage that undermines any increase in taxable income as the economy rebounds from its trough.

The resignation of former BIR Commissioner Rene Bañez, Deutsche Bank said, further illustrated the severity of the problem at the BIR and the need to keep expenditures in line. "With 2004 being an election year, this will be a test of political will," Deutsche Bank said.

Deutsche Bank said that given the current situation, the Philippines would see a cyclical upswing at some point, but it would be a muted one.