Politics threatens growth

BY KAREN L. LEMA, BusinessWorld Senior Reporter Politics remains the single biggest threat to the Philippines’ economic recovery, the International Monetary Fund (IMF) said on Tuesday. The same concern was aired by debt watcher Fitch Ratings, which said it may have to cut its Philippine growth forecast given the country’s political troubles. At the conclusion of its annual consultation with the Philippines, the US-based IMF warned growth may be jeopardized by political problems unless the government makes sure that its economic reform agenda is sustained. "A risk to the near term outlook for the Philippine economy is that political events, such as possible constitutional change, serve to sideline economic reforms. If reforms were to stall, investment is likely to remain subdued, and GDP (gross domestic product) growth will likely remain below 5% in 2006," the IMF said. The IMF forecast is lower than the government’s target of 5.7%. For 2007, however, the fund expects the country to grow faster at 5.6%, also higher than its previous projection of 4.7% and the government’s 6.1-6.5% GDP goal. It said the country faces two key challenges going forward and that is to "strengthen its defenses against the remaining significant short-term vulnerabilities", and to move the Philippine economy to a higher and more sustained economic growth path. Given the country’s high debt levels, the IMF said it remains vulnerable to financial shocks. Further spikes in oil prices or an outbreak of avian flu also pose additional near-term risks. "Directors therefore urged the authorities to sustain the reform momentum by completing the remaining agenda for fiscal and other structural reforms and thereby enhance the economy’s ability to absorb such shocks," the IMF said. Unsettling political developments can leave a country’s financial markets prone to abrupt changes in sentiment, with credit implications. Given that the Philippine government has one of the highest debt-to gross domestic product ratios (GDP) at 75%, it becomes more vulnerable to exchange rate shifts. It is therefore important to retain the confidence of financial markets by keeping a stable economic and political environment. The IMF’s Philippine Representative, Reza Baqir, noted that had it not for the implementation of the expanded value added tax (VAT), the impact of the government’s political troubles on the economy could have been worse. The implementation of the VAT, he said, served as a "shock absorber" as it gave assurances that the country’s public finances are on "safe footing", evidence of which was how markets quickly "shrugged off events" precisely because of the government’s strong fiscal position. UK-based Fitch, meanwhile, said "Asia’s political backdrop had recently become less favorable for growth, with worrying developments in the Philippines, Thailand and Taiwan." "Those sovereigns in the midst of political turmoil also have the weakest growth rates in Emerging Asia, and further downward revisions to the growth forecast may be necessary," said James McCormack, Senior Director and Head of Asia Sovereigns. Fitch said it forecasts Emerging Asia to grow at 7% this year, slower than the 7.5% in 2005, as export demand eases in line with a slowing of the US economy. "Notwithstanding ongoing regional integration with China, growth in Asia remains highly leveraged to external demand, and particularly the US consumer, whom we believe to be overstretched," Mr. McCormack said. The IMF, meanwhile, underscored the importance of further enhancing the investment climate through a stable macroeconomic environment, increased infrastructure investment, a stronger financial system, and improved governance. The government’s goal of balancing the budget over the medium term will require additional measures, on top of the VAT reform program put in place, it said. "[IMF directors] therefore encouraged the authorities to consider and pursue additional tax policy measures, such as a sufficiently ambitious rationalization of tax incentives, to broaden the tax net and improve efficiency and equity," it said. It also reiterated the need to expedite the privatization of the power sector to attract more investments, strengthening of financial and capital markets, the passage of the amendments to the central bank charter aimed at strengthening bank supervision. The IMF said it has agreed to extend the post-program monitoring framework for the Philippines for another year "in light of its facilitating role in reducing the country’s remaining fiscal and external vulnerability." Peso touches P50.88 to $1 The peso yesterday entered P50 to the dollar territory, hitting a new 3-1/2 year high of P50.88:$1 before closing virtually unchanged at P51.06, one centavo lower than Monday’s close. Traders attributed the peso’s strength to strong inflows from overseas Filipino workers, whom they said are sending more than the usual in remittances due to the school graduation season. The local currency is also expected to stay strong given the current level of government dollar reserves. "It’s really market-driven because of the strong inflows from dollar remittances," a trader said. Market investors are also more optimistic following the government’s of a narrower budget deficit for the month of January. The government on Monday reported a January budget deficit of P15.4 billion, lower than the target of P20 billion. Dealers expect the peso to sustain its strength this week, with some optimistic that the local currency may close within the P50-to-the-dollar level. Further propping up the peso, meanwhile, is the government’s relatively high level of dollar reserves. Bangko Sentral ng Pilipinas (BSP) data showed gross international reserves (GIR) at a new all-time high of $20.577 billion as of end-February due to aggressive borrowing by the national government. This was a 0.5% increase over the $20.480 billion reserve level reported in the previous month. BSP Governor Amando M. Tetangco, Jr. said the increase was due mainly to foreign exchange deposits by the national government from proceeds of its recent bond sale, as well as the BSP’s foreign exchange operations and income from investments abroad. "However, these inflows were partly offset by payments of maturing foreign exchange obligations of the national government and the Bangko Sentral," Mr. Tetangco said. The government borrowed $2.2 billion from the international market last month to finance operations and maturing obligations. The GIR represents the central bank’s total holdings of foreign currency denominated in dollars, its gold assets, and so-called special drawing rights with the International Monetary Fund. A large GIR stock helps insulate the domestic economy from inflationary pressure. A weak GIR position can adversely affect market confidence and trigger capital flight. Mr. Tetangco said the latest GIR level is enough to cover 4.4 months worth of imported goods and services and income. This "import cover" measures the ability of the local economy to sustain normal activity in the event that dollar inflows stop completely. This level is also equivalent to 3.3 times the country’s short-term debt based on original maturity and 1.8 times based on residual maturity. Net international reserves - GIR less maturing obligations, inclusive of the revaluation of reserve assets and reserve-related liabilities - stood at $19.936 billion as of end-February. The peso, touted as the best performing currency in the region, is expected to remain strong in the medium term as it continues to be supported by dollar inflows from overseas Filipino worker (OFW) remittances, portfolio and foreign direct investments. According to the central bank, the peso it will likely stay at P51-P53 level this year and P52-P54 in 2007 to 2010. The central bank has said it does not consider the recent appreciation of the peso as a threat to the economy’s competitiveness. While it may be true that the currency’s strength has been affecting the country’s major foreign exchange earners, the BSP said it should not at all set back competitiveness. Export competitiveness, it said, does not solely hinge on the foreign exchange rate because exporters can compete better through improved productivity and by finding new markets and new products. Likewise, a reduction in the pesos of OFW remittance beneficiaries would be offset by an increase in their buying power because the strong currency will also result in lower inflation. - Karen L.Lema/BusinessWorld