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The Philippine Economy in 2011: Risks and Challenges

By: BENJAMIN E. DIOKNO

The official government forecast is that the Philippine economy will expand by 7 to 8 percent in 2011 sustaining the strong economic rebound in 2010. But the growing consensus, among international financial institutions (the International Monetary Fund, the World Bank, and the Asian Development Bank), rating agencies, think tanks, local banks and individual analysts, is that GDP growth this year will be in the neighborhood of 5 percent.

The artificially strong 2010 GDP growth was mainly due to election spending and base effects, with the 2010 GDP number being compared with near zero output in 2009.

Not widely known to the general public is that the Philippine government is operating on two forecast numbers: the conservative, more realistic 5 percent this year and the targeted, more ambitious growth of 7 to 8 percent. This dualistic approach is embedded in the President’s 2011 Budget of Expenditures and Sources of Financing. But as the year progresses more downward risks are emerging, in support of the consensus number.

For purposes of estimating revenue targets, the Finance Department used the more conservative GDP growth of 5 percent. But as a target and for public consumption, the government would like to use the more optimistic, faster growth of 7 to 8 percent. These forecast numbers were generated more than half a year ago, sometime in June 2010.

But with new information coming in, I expect that the government will have to revise sooner rather than later.  The ambitious goal of 7 to 8 percent growth has to be downgraded to more realistic level. The two GDP forecasts have to be merged closer to the consensus number.

There is nothing wrong with revising the GDP growth forecast to lower, realistic number. In fact, not doing so is misleading (to the public and private firms who rely on government for good, accurate forecasts for their decisions) and potentially embarrassing.

The government, specifically its economic managers, would lose credibility and would have a lot of explaining to do, if the economy were to grow by 5 percent when the official forecast were 7 to 8 percent. On the other hand, the economic managers would appear intelligent if the economy were to grow at rates higher than the official forecast. 

Downside risks

A lot of things have happened since seven months ago. The Aquino administration has more up-to-date information now than then. The external and internal factors that could affect the performance of the economy have become more prominent.

The administration  has a more pragmatic assessment of the quality of the bureaucracy and how it works, the seriousness of the traps left behind by its predecessor, and by the quality of its own men and women.

First, the threat of inflation. The incumbent government is faced with the task of letting prices of essential commodities and services adjust. Rising prices could affect consumer demand and cost of production. But it would be a mistake not to let prices adjust. Doing so will only create more problems than solutions.

Rising prices will put pressure on monetary authorities to raise interest rates which would then affect the stock market and the value of the peso.

Second, the ability of the government to implement the budget on time and its impact on overall deficit. With the 2011 budget approval out of the way, the question arises: How soon can the economy feel the impact of higher social spending and the revival of public spending on public infrastructure?

The fact is that the level of public infrastructure spending authorized in the 2011 budget is smaller than the one authorized in the 2010 budget. With a smaller budget, the pressure for efficiency of public spending  is greater. The public expects capital spending this year to be better focused on well selected projects, to be quicker, and to have minimum leakage.

At this time, the government should already know which projects are ready for bid, awarded and about to start. The reality is that before any given project will get reflected in the national income accounts, it has to implemented first. Being listed in the budget does not count much. It is an important first step, but unless there real earth movements and mobilization of manpower, there is no real value added in construction activity.

And here the severity of the La Nina phenomenon comes in. Six months ago, the prediction is that the Philippines will be visited by a mild La Nina after a punishing El Nino. Now it turned out that the La Nina would be severe and prolonged. How would this affect construction activity which was supposed to take off during the summer months?

Third, how would La Nina affect Philippine agriculture? Last year, agricultural output was flat because of the lingering effects of Ondoy and Pepeng and the typhoons in late October.

In addition to La Nina, there are other negative external factors looming in the horizon. These are the growing tight-money policies of the industrial world, the reverse flow of hot money, and China’s potential great fall.

Fourth, from concerted, synchronized fiscal and monetary easing at the height of the crisis, most of the industrial world have rediscovered fiscal conservatism. The fiscal tightening is happening in all of Europe and to a limited extent to the U.S. This spells bad news for our exports and for our overseas Filipino workers. With unemployment stubbornly high in host countries, the demand for overseas workers is expected to slow.

Fifth, with interest rates beginning to rise, and a respectable recovery in the US gaining traction, there is a strong likelihood of reverse flow of hot money from developing countries, especially in Asia, back to the industrial world. That’s bad news for the equities market. The recent sharp correction of the Philippine stock market is a reflection of this reversal of fortune.

Sixth, an economic slowdown of China and its impact on the global economy. Is this the year China’s property boom would finally suffer a great fall?  The newest economic superpower happens to be the biggest buyer of natural resources in the world. If China’s growth contracts by 5 percent (from 10 percent), world commodity prices could plummet by as much as 20 percent, the ratings agency Fitch estimates in its recent report. The inescapable conclusion is that a sharp fall of the Chinese economy would have serious collateral damage to the rest of the world.

Major Challenge: How to Make the PPP Initiative Work

So much faith is placed on the public-private partnerships (PPP) initiative. But how many projects under the PPP initiative have been identified, carefully studied, awarded and ready for implementation? The PPP initiative could make or break the government’s ambitious target of 7 to 8 percent average growth in the next six years.

For the PPP initiative to succeed, certain preconditions have to be met. First, the projects have to be well selected. A poorly selected project (say, an airport in a remote province or a major road in an island province) is a drain on public finances, no matter how efficiently the project is implemented.

Second, the sources of financing have to be clearly identified. If the government plans to spend 5 percent of GDP for public infrastructure, that would amount to about P450 to P500 billion annually. How much of that amount will be provided for in the national budget, how much will be the share of the government corporate sector, how much will be the share of local governments, and how much will be through the PPP initiative?

Third, policy consistency and credibility. Can investors trust that the government will honor its commitment with respect to price setting and risk sharing. Recent experiences with MRT, SLEX and NAIA-3 are grim reminders of what could go wrong when investing in the Philippines. Can the current administration and those that will follow it be trusted?

The year 2011 is a critical year for the Philippine government. It’s a turning point. If the Aquino III administration succeeds in adopting policies and decisions that would attract the  interest, respect and admiration of the investors, then growth in future years would be more robust and sustained. But if it muddles through and potential investors were unimpressed, then growth in future years would be weak and erratic.