Politics a sticking point

Economic reforms could be blocked by mounting political noise over proposals to change the 1987 Constitution, negating recent gains made by the government in the fiscal front. This concern was raised by both UBS Securities - which also cited risks in the government’s plan to front-load spending - and the second biggest bank in Europe, the Royal Bank of Scotland. Reporting on a recent trip to Manila, the Royal Bank of Scotland highlighted a recent string of economic good news, particularly the implementation of the new value-added tax or VAT law which could improve the government’s finances. "We left Manila quite bullish on near-term prospects for the [Philippine peso] and Philippine bonds," said the financial services giant, which has nearly 35 million customers in the United Kingdom and worldwide. But while there have been improvements, the bank said "This is not the world’s next big restructuring story." "The achievements of the past year on the fiscal front have dragged the country back from the edge of a precipice, but they’ve hardly scaled the reformist mountain. Politics, as always, remains the sticking point," it said. REVENUES MAY NOT BE ENOUGH In a research note, meanwhile, the brokerage arm of UBS Investment Bank said it has a "somewhat more cautious view of fiscal targets for 2006" owing to the possibility that the growth in revenues might not be able to keep up with a government plan to frontload its expenditure. "The possibility of a higher budget deficit for the first quarter of 2006 versus the first quarter of 2005 risks confusing the market watchers at a time when the entire focus is on the fiscal numbers. Besides, frontloading bears the risk that it cannot be cut back should tax revenue come in below target," UBS said in its update on the Philippine economy. President Gloria Macapagal Arroyo has announced that some P35 billion in savings from 2005’s budget will be used to finance pump-priming activities this year. The Executive has already allocated the still to be collected P75 billion from the expanded value- added tax (VAT) this year, with social and economic services and infrastructure to get P22.5 billion. The rest will be used to reduce this year’s deficit, which is estimated to reach P125 billion. With no other tax legislation planned at this stage, the government’s ability to sustain its deficit reduction program is "entirely contingent on the EVAT (expanded VAT) being successful," UBS said. UBS said the government’s overall tax-to-gross domestic product (GDP) ratio target of 14.6% this year is in fact higher than its "conservative estimate" of 14%. The difference may still be offset by higher non-tax revenue, however. "The budget deficit and particularly, the tax revenue data will no doubt be the most closely watched macronumbers in the Philippines this year," it said. The strength of the peso is a source of optimism, UBS said as it projects the local currency to stay at P51-52 range for the year. UBS said that while it expects the Bangko Sentral ng Pilipinas to remain tolerant of exchange rate appreciation, the "political noise" is something that needs be closely monitored given that it will "likely keep appreciation pressure in check." "While the chance of extra-constitutional challenges is believed to be low by political observers, constitutional challenges, on the other hand, are most likely to increase in the months ahead," UBS said. "The two events that we would monitor are the discussions and preparations surrounding a change in the constitution to pave the way for a unicameral parliamentary system and the probable renewed impeachment proceedings against President Arroyo once the on-year grace period lapses at the end of June," it said. The Royal Bank if Scotland, meanwhile said the government would likely meet its target additional revenues from the new VAT law. But tax collections as a percentage of GDP, while expected to rise to 14.6% this year from 12.5% in 2004, are still "paltry." "A significant question in our mind is how much of [VAT revenues] will be spent going forward, but the low tax revenue/GDP data underscores the Philippines’ fiscal problems as squarely revenue-related," the bank said. There is also "no clear program" for fiscal consolidation beyond 2006, the bank said citing local analysts, although the government wants to eliminate the budget deficit by 2008 and that of the entire public sector by 2010. "These may well be forthcoming but they are hardly guaranteed," it said. "The fact that either or both of 2007 and 2010 could be election years does not bode particularly well for meeting the targets." The bank also pointed out that debates over charter changes are centered prolonging President Gloria Macapagal Arroyo and her allies’ hold on power. This is despite "the need for reforms that extend to key questions such as tax reform and clarification of the policy for foreign ownership of land," the bank said. "Political focus is on maintaining power, not enacting further reforms." INVESTMENTS NOT ENOUGH Efforts to attract more investments should be strengthened, as the Philippines was able to attract only $1 billion in foreign direct investments (FDI) last year. "Over the past 15 years, the most FDI the Philippines has managed to secure in a single year is $1.75 billion," the bank said. Mining, though, could be a big boost, it said. "The potential money to be made from mining almost ensures that the sector will remain open to foreigners, and there are hopes that the first major projects will be announced in 2006." Business process outsourcing (BPO) is also the "major growth area" for Philippine exports. But at $1 billion to $2 billion in annual sales, it is still small relative to the country’s export base of $40 billion, which is dominated by electronics. "BPO has created around 75,000 jobs and has fed a 16% [year-on-year] rise in commercial real estate prices in Manila. Electronics, on the other hand, is very low value added," the bank said. The success in BPO, though, comes from the fact that there are many English speakers and the infrastructure is already in place. "Where infrastructure is needed, investment will continue to fall woefully short barring a surprise change in the political backdrop. Cha-cha does not look likely to deliver these changes." - Felipe F. Salvosa II and Karen L. Lema/BusinessWorld