Fiscal stimulus: Not one size fits all

With private sector demand all but withered as the world falls into a synchronized recession, everyone is urging governments everywhere to have bold fiscal stimulus programs. But fiscal stimulus is not like some powerful broad spectrum antiviral drug that can be prescribed to anyone to mitigate the local impact of this global economic influenza. Economist Romy Bernardo, writing a memo for the New York think tank Global Source, cautions that people sometimes overlooked the difference in country situations.

Indeed, the IMF said, “While a fiscal response across many countries may be needed, not all countries have sufficient fiscal space to implement it since expansionary fiscal actions may threaten the sustainability of fiscal finances. In particular, many low income and emerging market countries, but also some advanced countries, face additional constraints such as volatile capital flows, high public and foreign indebtedness, and large risk premia.”

In short, Mr. Bernardo explains, what is appropriate for the US or China may not be appropriate for a country like the Philippines. Let us not forget that “the US, though at center of the storm, is still owner of the printing press for the world’s reserve currency (comprising over three-fifths of the world’s international reserves and figuring overwhelmingly in international trade)… The same goes for most countries in the Euro-zone. China on the other hand has abundant international reserves (a couple of trillions), as do Japan and many other East Asian countries.”

In other words, governments must still mind their fiscal health, specially governments of a country like ours. It is worrisome to find out that in the name of fiscal stimulus, Congress passed a P1.415-trillion national budget bloated with pork barrel funds and tried to keep within the legal limit set in the Malacañang budget proposal by cutting P35 billion out of the automatic appropriation for debt service.

The problem is explained by a Malacanang budget official: “The debt service funds in the 2009 budget are already programmed based on an assumed peso-dollar rate. If the President does not veto the huge P35 billion reduction and the government makes the debt payments based on the assumed exchange rate, that will increase the budget deficit by an equal amount.”

But even a veto of that P35 billion reduction in debt service appropriation may not solve the problem because the pork funds have already been hidden in the huge increases in the budgets of agencies. The budget remains bloated by P35 billion, which is technically not legal. Ate Glue must also veto those increases, line by line.

The reality of our situation was well expressed by the Bernardo memo: “while recent fiscal, monetary, banking and debt management reforms have strengthened the ability to cope with the raging economic storm, the country has only limited fiscal and debt headroom and still relies heavily on domestic and international capital markets, which continue to be bugged by risk aversion.

“Debt-to-GDP ratio while having been brought down from a high of 78 percent in 2004 to only 57 percent last year (as of the third quarter) is still high relative to similarly-rated peers by 10 percentage points and still higher than the lows achieved 10 years ago. At the time, we were only a notch below investment grade compared to four notches below the standard today.”

Bernardo’s advice for caution is significant in the light of misleading hosannas following our successful bond float early this month. “While recent borrowing by the Bureau of the Treasury had been inspired (in terms of timing and in opening access to private sector borrowers early in the year), it was still at a high of six percentage points over US Treasuries, revealing continued skittishness of investors for Philippine securities and other emerging market and corporate issues (that is, anything except US Treasuries.)”

But we can afford some amount of fiscal stimulus. Bernardo cited a new paper of Dr. Philip Medalla. The UP economics professor thinks government can afford a public deficit of two to three percent of GDP (P150 to P200 billion) – and keep its debt ratio on a declining trend.” But the caveats are significant – if government has a buoyant tax system (tax effort not declining), if it makes better use of taxpayers’ money, and if macro stability and fiscal credibility can be maintained and off budget deficits significantly reduced.

Philip is particularly worried about surprises. The fiscal stresses over the past three decades, it was pointed out, have not come from the national government deficit but rather from surprises from contingent liabilities.

Bernardo recalls some of those surprises: “the multi-billion peso GFI guarantees that led to the debt crisis in the 1980s (e.g. DBP, PNB and Philguarantee), the P300 billion or so worth of old central bank debt arising from non-transparent quasi-fiscal functions (including protecting consumers from foreign-exchange driven increase in oil prices), and more recently, the P200-billion liability of the National Power Corp. (NPC) assumed by the national government as part of the privatization exercise. The latter included some servicing of NPC debts from 2000 to 2004 that were not passed on to consumers for political considerations.

Bernardo warns that “as government talks about a fiscal stimulus – or what they have labeled as the Economic Resiliency Package – to protect growth, it behooves us to remember how fiscal surprises in the past have raised the cost of credit to high levels. In the extreme case, such actions have inadvertently contributed to debt and financial crises, incidents that exact a toll in growth and employment by far higher than the incremental one or two percentage points of GDP growth that government hopes to elicit.”

Examples of contingent, off-budget risks we should watch include: borrowings of government corporations like the NFA guaranteed by the government. There are also potential risks in the National Development Corp. (NDC) and other GFIs providing seed money – under reportedly “sovereign guarantee” – for a P100-billion fiscal stimulus package lately being championed by the Philippine Chamber of Commerce and Industry to demonstrate their loyalty to Ate Glue at no cost to them.

Other possible sources of contingent risks include the explicit and implicit guarantees provided to failing banks, perhaps including a syndicate of rural banks, and the opaque accounting of some GFIs and government corporations. How much did the GFIs really lose in their Wall Street investments? And we are not talking of just GSIS!

Then, our ability to undertake fiscal stimulus also depends on developments like an expected decline in tax collection due to slower economic activity and lower corporate profits, as well as to a lowering of the corporate income tax rate from 35 to 30 percent, exemptions granted to minimum wage earners, and continuing non-indexation of sin taxes. There will also be the unusual drop in customs duties from sagging imports, particularly oil, due to smuggling as well as a decline in consumption.

Bernardo reminds government that we are still in a period of heightened risk aversion. “Given the high exposure of commercial banks to Philippine government debt in a mark-to-market setting, the translation to financial losses of the banking system and loss of confidence can be fairly swift and devastating.” In other words, INGAT LANG.

Mr. Bernardo is supportive of fiscal stimulus at this time. But it must be controlled and transparent. He thinks the conditional cash transfer program (e.g. grants to the poor provided their children stay in school) delivers an excellent fiscal stimulus because it is not only effective (translates immediately to consumption and GDP increase) but also has the ability to alleviate poverty.

In this regard, Mr. Bernardo cited “the broad public confidence in the leadership of the Department of Social Welfare and Development (DSWD) and the sponsorship and technical support of the World Bank, which already has many success stories under its belt (notably, Indonesia and Brazil). By contrast, we should beware of rushing spending on ill-prepared projects that will unlikely result in any activity, and in the event that they do, will probably just be wasteful (think fertilizers in 2007 and the North Rail-ZTE project still waiting or still borne).”

The bottom line is, as I have said in previous columns, will Ate Glue have enough credibility to do this stimulus program professionally and with a good amount of patriotism? How we weather this global economic crunch depends on that.

Gift certificates

From Mary Ann Quioc-Tayag.

Hi. I agree with you en toto re gift certificates should not expire and are like cash. I often have GCs that expire because I only buy when I need things. Could you tell me please if National Book Store decides to make thier GCs like Rustans because I too have expired GCs from National.

Thanks very much. Always enjoy reading your columns.

Cheers

In America – Obama! Obama!

In Manila – Baba na!  Baba na!

Boo Chanco’s e-mail address is [email protected]