Even if there were no external and political risks facing the Build Build Build program of infrastructure, economic risks present themselves in several forms.
“Economic risk.” The chance that an economic factor or variable turns out be to be different from its usual expected behavior essentially describes what we call economic risk. The management of risk is important for the nation not only to control cost but also to achieve the potential benefits.
I single out several likely economic risks at present: (1) inflation; (2) exchange rate changes; (3) interest rate changes; (4) the contractor choice; and (5) absorptive capacity.
Other economic risks could be elaborated with any of the above. For instance, under more strained economic conditions, a balance of payments crisis or a debt crisis could be discussed.
“Inflation, or rising prices.” Rising prices threaten the cost of projects and could lead to the rearrangement of priorities. Changes in priorities might arise from an effort to curtail the inflationary spiral within a macroeconomic framework.
In general, inflationary rates such as what we currently experience – the recent surge in prices around four to five percent per year – might not yet be due cause for alarm. But higher rates of inflation would induce stronger anti-inflation counter-measures.
Such concerns could initiate cutbacks in fiscal spending, or of reduction of overall credit. When spending cuts are in order, the priorities of spending become more important, requiring a trade-off between current programs (consumption) and investment. Which wins depends on the strength of society’s needs.
Also, it might become a trade-off among specific projects. Which ones proceed, which ones get postponed, reduced or chopped off.
“Exchange rate: the peso’s external value.” The peso exchange rate could be the channel for the risk. The peso’s fall in value – a depreciation – could also induce other outcomes, some not wanted, others wanted. Under current conditions, a depreciation of the peso is more likely than an appreciation since large expenditure activities tend to create additional demand.
Undesired consequence would be rising domestic prices. Unwanted too would be an increase in the value of foreign debts that are incurred or to be paid: depreciation means more pesos to pay a given foreign dollar.
A depreciation of the peso however could also trigger a rise in export incomes as the value of exports to foreigners fall. This would be a positive development. Another impact is that depreciation of the peso raises the cost of imports, also a positive development if imports need to be reduced.
(Recent experience in Indonesia and Vietnam has seen impressive growth of exports in the presence of the depreciations in their currencies and the high rates of domestic inflations they have experienced. These developments propped up their balance of payments position.
(Such expansions of their exports have been triggered by high inflows of foreign direct investments in their export sectors. Relatively, they have less restrictive regulations covering direct foreign investments than ours. Moreover, this channel of relief might not be as certain today, given that there is a global cloud of trade war.)
“Interest rate increases.” Rising interest rates are more likely to happen in the present scenario. During the last few years, interest rates have been low globally, thanks to the effort to spur economic recovery after the great recession of 2008. The immediate problem now involves a a program of rising interest rates foreseen as a natural adjustment in the US for the return to economic growth.
The Philippine program of interest rate adjustments, which echo or follow those taken by other central banks, is a defensive measure undertaken by our central bank to protect the economy from investment outflows, thus creating counter-measures to make investments at home less vulnerable.
A major consequence of rising interest rates is to increase project costs directly for borrowed funds. This changes the incentive patterns for many economic development projects, since they are mostly often financed partly from debt.
In fact, most development projects in infrastructure are financed from debt. The blend of current funds to debt is heavily in favor of borrowed money. When TRAIN, package 1, generated a lot of revenues to help finance the Build-Build-Build program, it mainly improved the capacity of the government to backstop its borrowing program for economic development.
“Contractor risk.” There is always the possibility that a project could have higher cost or incur some failure of delivery of the original objectives because of the wrong choice of contracting parties. This could happen whether the source of financing is official development assistance or some private contracts, as in PPP (public-private partnership) projects.
Corruption contributes to the prevalence of poor implementation of projects because of contractor failure. Ill-prepared government agencies could become sources of poor governance of contracts.
Political culture in the nation’s governance might be a big contributor to the cases of poor outcomes in contractor choices in the past. There is a nexus between corruption and political culture. But this is not to say that the move toward a better system is not happening.
In the course of time and experience, the nation has learned from some of the big mistakes. Also, there has also grown a larger community of contractors for government projects, especially in the public works area. The vigilance of society also improving.
But so far, most of the big PPP projects currently under implementation have been dominated mainly by current big business groups in the country. There have been no big projects in which reputed outside, foreign groups with high reputation have been heavily involved.
The best way to improve the contracting system is to allow greater participation of more bidders for government contracts, to include of course the most important infrastructure projects of the government. Improving the rules of contracting would encourage a wider list of potential contractors to the government.
“Absorptive capacity.” An important factor that abets poor choices of contracting as well as poor performance in the implementation of big projects is the problem of absorptive capacity.
We have too many obstacles in regulatory framework, in procurement processes, and in labor force regulations that restrict absorptive capacity. One important need is to acquire these skills through s more open framework of economic liberalization.
I have made an attempt to address this issue in one column in the past. See Crossroads, Feb. 27, 2013, “A nation’s absorptive capacity and its current relevance.”
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