Focus on manufacturing proposed amid downturn

MANILA, Philippines - Developing countries like the Philippines should strive for an economy that encourages more manufacturing amid a prolonged global slowdown and an end to the commodity boom, a new report by a UN agency said. To do so, tax incentives for local companies to re-invest profits, more bank lending, and low interest rates are needed. The Trade and Development Report 2008, issued by the United Nations Conference on Trade and Development (UNCTAD), said developing countries should encourage financing of investments in the production of more sophisticated goods. The preferred financing sources for these investments, the report stated, are company profits and bank credit and not money borrowed offshore. "Among domestic sources of investment, self-financing from retained earnings is the most important, and most reliable ... Bank credit is the second most important source of financing for enterprises, particularly for new businesses and small and medium-sized firms," an UNCTAD statement on the report said. Retained profits of private firms are preferred over household savings and foreign capital to finance investments because they are more likely to result in productive ventures, the report stated. These corporate re-investments were said to have spurred the economic catch-up of East Asian countries after World War II. Philippine Institute for Development Studies (PIDS) President Josef T. Yap agreed, saying in an e-mail that "Investments should be financed through retained corporate earnings ... This type of funding is readily available now ... Profits have been increasing sharply at least in the past eight years." Banks should also increase loans to domestic companies, the UNCTAD said, as financial institutions have an informational advantage over individual savers in choosing which projects are worth supporting. Lending up, but... Central bank data show that banks lent a quarter more money in June compared with the same period last year, although the growth was mostly due to credit card receivables and not production-related loans. Governments were advised to design policies that would make bank credit more accessible to local firms and encourage these firms to re-invest profits for expansion. "Possible measures include a range of fiscal incentives and disincentives such as preferential tax treatment for reinvested or retained profits, special depreciation allowances, and high taxation of income from speculative activities," UNCTAD Secretary-General Supachai Panitchpakdi said in the overview of the report. The report called on public financial institutions to provide credit to select investments such as those in infrastructure, and research and design. Creating stricter rules for loans intended for consumption could also direct credit to investments, it said. Government guarantees may also be awarded to private firms applying for loans to finance investment projects. But Mr. Yap said a government-led credit initiative would likely fail because of corruption, and if the private sector is left in charge, there could be "coordination failures." "Investments must be made simultaneously in several sectors for individual investment projects to succeed. For example, an airport has to be built for a tourism project to succeed," he said. Warning on rates, wages The report also warned against high interest rates and excessive nominal wage increases. Monetary policies that tended to focus on avoiding inflation, the report said, have yielded low levels of investment and slow growth. "When interest rates are too high, they have a negative impact on the most important sources of financing for investment: company profits and bank credit," Mr. Panitchpakdi said. Although the report warned that interest rate hikes could hurt these two finance sources, it clarified that adjustments were justified in the face of rising prices. The central bank raised interest rates for the third straight time last week, reasoning that above-target inflation was expected for both 2008 and 2009. The UNCTAD report said: "In countries where inflation pressure is increasing ... tighter monetary policies may ultimately become necessary." It noted that second-round effects of wage increases in the Philippines and other countries warranted rate hikes. Several Philippine economists weighed in on the issue as well. "Raising interest rates makes domestic financing more expensive [but] I agree with the mandate of the central bank," former Socioeconomic Planning Secretary Benjamin E. Diokno said in a telephone interview. He said rate hikes were needed to stabilize prices. PIDS senior research fellow Gilbert Llanto, for his part, said, "I think the central bank is doing a good job in managing liquidity because the fear now is inflationary pressure." Otherwise, he said, high inflation would discourage investors. - BusinessWorld