MANILA, Philippines - The country needs to increase its tax effort and investment rate to help stem the currency appreciation caused by a surge in capital flows it experienced last year after the 2008 global financial crisis.
This recommendation was made by Josef T. Yap, a leading economist and president of the Philippine Institute for Development Studies (PIDS), in a paper titled “Managing capital flows in the Philippines.”
Yap said that exercising fiscal restraint and increasing the investment rate are among the areas where policy measures can help stem the local currency’s rise or reduce overheating brought about by capital inflows without having to resort to sterilized intervention.
Sterilized intervention has been the common form of response to the impact of capital flows among the emerging markets, including the Philippines.
It involves the exchange of domestic bonds for foreign assets, often through open market operations, designed to neutralize the increase in base money arising from the purchases of foreign currency.
Through sterilized intervention, countries experiencing surges in capital inflows can maintain the nominal exchange rate while also preventing the capital inflow from increasing the balance of base money.
Data indicated that intervention was heavier in the Philippines during the period 1998-2007 compared with 1987-1997. Sterilization was also more pronounced in the post-crisis period.
“Overall, intervention – usually measured as percentage change in the level of international reserves-has been mildly successful in reducing the volatility of exchange rate movements,” Yap said.
Because of the deterioration in the fiscal situation in 2009 and 2010, he said, better fiscal management – particularly in increasing the tax effort – has become an important tool in responding to the surge in capital inflows in 2010.
The paper noted the historically low investment rate in the Philippines that can be attributed to supply side constraints and institutional factors.
“The government has to address these issues and the private sector has to display more ‘animal spirits’ in order to raise the investment rate in the Philippines,” Yap stressed. “A higher investment rate will lead to more imports which will reduce the current account surplus.”
The large inflows of remittances from overseas workers have resulted in a current account surplus. This contributes to an increase in foreign exchange reserves which in turn exerts pressure on the currency to appreciate.
The paper also discussed the use of capital controls to address surges in capital flows which have proven to be effective in several economies.
The International Monetary Fund (IMF) has raised concerns that widespread use of capital controls by emerging markets will have negative effects on the efficient allocation of investment across countries and also constrain necessary steps to address global imbalances.
Yap pointed out that the arguments of the IMF, however, do not take into account the scenario wherein the private investors can readily punish countries for imposing capital controls by taking their money elsewhere.
“Unilateral action will therefore be less effective. Capital controls will be a more effective policy tool if implemented in the context of regional cooperation,” he said. – PHILEXPORT News and Features