Optimism bias

In her latest book, Political Risk, Condoleezza Rice pointed out the danger of “optimism bias” in predicting everything from outcome of business investments, sports events, political events and calculations of personal risks.

“People tend to expect that their investments will perform better than average; that good fortune events will happen more to themselves than to others; that their favorite sports team has a higher chance of winning than it actually does; and that their preferred presidential candidate will win an election even when the polls suggest otherwise…

“Optimism bias helps explain why financial markets, political leaders and so many experts were stunned by the United Kingdom’s June 23, 2016 vote to leave the European Union.” 

Hmmm… so now there is an explanation for the shock some of our policy makers experienced, specially at the BSP, over our inflation rate as well as the trajectory of the peso forex rate.

Now the BSP is saying they expect more dollar outflows and they are blaming it on our trade imbalance. They are expecting the value of the country’s imports to outpace what we earn from exports by over three times its original forecast.

The BSP is now saying the country’s current account would likely end the year at a deficit of $3.1 billion, or a 342-percent increase over the original deficit projection of $700 million announced in late 2017. Exports are seen growing by 10 percent and imports climbing by 11 percent YoY.

But the central bank is saying not to worry because this large deficit will be propped up by service-related inflows and the entry of more foreign capital. That’s optimism bias again.

OFW remittances aren’t as robust as it has been, even if it is still showing modest growth. As for BPOs, there is a lot of nervousness over the effect of TRAIN 2, so expect moderate growth.

There will still be the confluence of factors working against the peso, the most significant of which is the widening trade gap. The strengthening of the dollar is a factor, but then why are other ASEAN currencies doing better?

UP economist JC Punongbayan noted that “other ASEAN currencies – like the Thai baht, Malaysian ringgit, and Singapore dollar – have even strengthened significantly against the US dollar.” This suggests, according to Punongbayan, that factors peculiar to the Philippine economy are causing the peso’s weakness.

“At P53.3 per US dollar, the exchange rate is now beyond the expectations of Duterte’s economic managers, who said back in April, they expect the peso to hover only between P50 to P53 per US dollar in 2018 up until 2022.” 

Actually, Punongbayan points out, “the continued weakening of the peso has been going on since 2013… months before the Duterte administration, all ASEAN currencies were weakening against the dollar, but the Phl peso weakened the least. In other words, we came out as one of the strongest currencies in relative terms…

“Fast forward to June 2018, the Thai baht, Malaysian ringgit, and Singapore dollar have all significantly strengthened against the dollar, while the Vietnam dong and Indonesia rupiah have weakened against the dollar, but only slightly. Today, the peso stands out as the weakest in the region.”

“When Duterte took office, our total reserves could pay for as much as 10 months’ worth of imports. In May 2018, this so-called “import cover” – which measures the adequacy of our foreign reserves – is down 7.7 months.

“Exports have been sluggish despite the usual claim of Duterte’s economic managers that the weak peso will make exporters ‘more competitive.’ In fact, exports have shrunk continuously since January 2018.”

The UP economist thinks the weakening peso is due to “three likely reasons: a widening trade deficit, weak OFW remittances, and some degree of capital flight.”

Duterte’s economic managers keep on saying the trade gap is because we are importing a lot of capital goods needed for Build Build Build.

Indeed, as of April, imported “raw materials and intermediate goods” jumped by 12 percent from last year, imported “capital goods” by 29 percent, and imported “consumer goods” by 30 percent.

But in the months before TRAIN 1 went into effect, included under “capital goods” are cars whose importation surged in anticipation of higher sales tax under TRAIN 1. Maybe this time we really are importing productive capital equipment and not more contributors to Metro Manila’s traffic jams.

Than there is capital flight. The peso had no doubt been weakened by massive exodus of portfolio capital from the local stock market. With a strong dollar, investors are moving their money back to the US.

It wouldn’t have been too bad if we also experienced strong capital inflows or FDIs. But that’s not happening in the magnitude we need to counteract the capital outflows. We still have laws to amend, bureaucratic processes to streamline to be friendlier to FDIs.

Also contributing to capital outflow are local investors moving capital out of the country. Conglomerates like Ayala and MPIC are investing in infrastructure in ASEAN countries where they feel they are more welcome. After all, the Duterte economic managers are not too hospitable to PPP investments.

Then, the Philippines slid by nine notches in the 2018 World Competitiveness Yearbook, with the biggest decline in “economic performance”.

There are also investors on the sidelines waiting for what happens to TRAIN 2.

Finally, there is political risk. As Punongbayan pointed out, “a number of investors continue to be spooked by the pernicious policies and politics of President Duterte.” Decisions like land reform in Boracay are made on a whim.

I guess we know our problems and we know what we are supposed to do. But will our economic managers be continually blinded by “optimism bias” and deny the obvious mistakes they have made so far?

Boo Chanco’s e-mail address is [email protected]. Follow him on Twitter @boochanco.