Intnl Financial Pol
Intnl Financial Pol PUBPOL 542
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Date Created: 10/29/15
Philippines Macroeconomic Performance and Challenges 200072005 PUBPOL 542 Huazhong Wang April 9 2006 I Introduction Although Philippines was less severely affected the 1997 Asian nancial crisis slowed its economic development and shrunk its growth rate to about 05 in 1998 from 5 in 1997 Afterwards the economy has been gradually recovered After experiencing a slower growth in 2001 the GDP growth rate increased to about 5 percent in 2005 slightly lower than the growth rate of 6 percent in 20041 In this report given the current macroeconomic performance and challenges facing Philippines we will be providing macroeconomic policy recommendations and also discussing their possible limits II Major Economic Indicators and Macroeconomic Problems 0 GNP Growth Recovered from the GNP decline during the Asian Financial Crisis in 1997 Philippine GNP expanded by 34 percent in 1999 and 44 percent in 2000 but slowed down to 18 percent in 2001 in the context of a global economic slowdown an export slump and political and security concerns Since the mid 2001 when President MacapagalArroyo took office economic reform has been moved forward In 2004 the Philippine economy grew by 60 percent re ecting a continued resilience of the service sector and an enhancement of exports and agricultural output The GDP per capita growth shares the similar trend with GDP growth In 2005 GDP per capita reached 1118 US Dollars implying an 11 growth rate compared to 1007 US Dollars in 20042 0 Unemployment Unemployment has long been a problem for Philippine economy In January 2006 the recorded unemployment rate was 107 percent3 a slight decrease of 06 percent from 2005 s 113 percent implying that the Philippine s government might not have done enough for reducing unemployment The recent government policies that Philippine government has tried to contract government expenditure and increased tax revenue in order to resolve the problem of government deficit may have exerted a negative effect on unemployment reduction In addition the stronger exchange rate and the resulting decline in export could have put pressure on employment rate due to its negative effect on industrial and agricultural production 0 Government De cit and Tax Revenue Historically Philippines has had a bad record of high government budget deficit These years the Philippine government determined to focus on deficit reduction Main methods being used are to increase tax revenue as well as to control government expenditure The recent enactment of the expanded Value Added Tax VAT law signed by President MacapagalArroyo between December 2004 and May 2005 has been 1 Data are from International Monetary Fund 2 IMF Philippines 39 Sla Reporlfor the 2005Arlicle IVConsulIalion andPosl Program Monitoring Discussion March 2006 182006 International Monetary Fund Country Report No 0 692 3 This is measured by the old definition for comparison purpose The unemployment rate measured by the n ew definition is 81 Philippine Labor Force Survey National Statistics Office httpwwwcensusgovph datapressrelease2006lf060ltxhtml greatly increased the Philippine govemment s tax revenue by 15 percent The non nancial public sector de cit has been reduced from 55 percent of GDP in 2003 to 325 percent of GDP in 2005 It is estimated that with the execution of the second phase of the VAT reform the de cit should be decreased further to 225 percent of GDP in 20064 Despite the longrun bene ts that the VAT generates for Philippine economy it may also add uncertainties to the shortterm economic growth prospects Besides in order to maintain sustainable economic development the Philippine government may need to consider developing its tax collection capacity by opening up new taxable resources and by increasing the ef ciency of executing tax laws other than merely raising tax rates for certain industries and products 0 Exchange Rate Current Account and Trade De cit The 4 percent increase of Philippine Peso against US Dollar indicates a tightened supply of domestic currency originally aiming to reduce in ation In addition the higher exchange rate is also partly due to the country s recovery from the 1997 Asian nancial crisis5 as well as the in ow of foreign investment Also since the nancial crisis the economy has been growing at a relatively high pace which may help increase investors con dence in the Philippines economy leading to an appreciation of the economy that has been represented by a strengthened exchange rate though a fundamental change of expectation still needs additional evidence Because of the higher exchange rate Philippines has been running a trade de cit since 2003 though its increasingly huge amount of remittance from overseas Filipino workers OFW6 has contributed to a surplus Current Account Even though exports grew by 25 percent in 2005 it is still less than import resulting in a trade deficit The relative decrease of export could have a negative impact on total output and may also retard the unemployment reduction Facing the competition from neighboring emerging economies such as China and Malaysia the Philippine government has been aware of the trade deficit problem 0 Potential Risk of In ation The recent increase of in ation rate is directly due to the increase of oil price In ation rose to 85 percent in April 2005 but declined to 66 percent by December Nonetheless in ation averaged 76 percent in 2005 well above the target range of 56 percent7 8 In addition the increase of minimum wages and the huge amount of 4 IMF Philippines 39 Sta Reportfor the 2005 Article IVConsultation andPost Program Monitoring Discussion March 2006 182006 International Monetary Fund Country Report No 0 692 5 During the crisis the peso fell significantly from 26 pesos per dollar at the start of the crisis to 40 pesos b y the end of the crisis 6 In 2004 the amount of remittance reached 3412 billions of pesos 7 IMF Philippines 39 Sta Report for the 2005 Article I VConsultation and Post Program Monitoring Discussion March 2006 182006 International Monetary Fund Country Report No 0 692 3 IMF Philippines 39 Sta Reportfor the 2005 Article IVConsultation andPost remittance may also contribute to a higher in ation rate Even though the in ation of 7 percent is acceptable for a developing country and we could consider this as a temporary situation it is still a little higher compared to its former experience Future potential risk of high in ation still exists 0 Uncertainties of Politics and Policies In 2001 the former President Joseph Estrada s administration was ruined by political scandals causing a signi cant falls in the share prices of companies listed on the Philippine Stock Exchange Later the President was impeached and nally resigned After the current President MacapagalArroyo took office economic growth has been bene ted from political stability however Philippines internal political climate is still a concern of both domestic and foreign investors The recent political disputes the initiation of the controversial VAT law and the longlasting problem of corruption have put uncertainties on future Philippine economic performance 111 Policy Recommendations 1 Monetary Expansion 0 Even though monetary policy should remain vigilant against possible supply shocks such as the recent oil price hike expanding the money supply is inevitable in the Philippines current economic situation A temporary increase in the domestic money supply will improve the continuing trade deficit by depreciating the current spot exchange rate and decrease the unemployment rate which is surprisingly as high as 11 annually i2 11 St S2 S 1 i SeSS 0 returns MdrY m MS 1 1 MS2 M Program Monitoring Discussion March 2006 182006 International Monetary Fund St DD 2 n sz 81 1 9 AA AAl Y1 Y2 Y An increased money supply shifts AAl upward to AA2 but does not affect the position of DD The upward shift of the asset market equilibrium schedule moves the economy from point 1 with exchange rate El and output Yl to point 2 with exchange rate E2 and output Y2 An increase in the money supply causes a depreciation of the domestic currency and expansion of output and therefore an increase in employment What economic forces produce the movement from point 1 to point 2 At the initial output level Yl an increase in money supply pushes down the home interest rate i In order to preserve interest parity in the face of a decline in i the exchange rate must depreciate immediately to create the expectation that the home currency will appreciate in the future at a faster rate than was expected before i fell This domestic currency depreciation makes home products more competitive by making them cheaper relative to foreign products ltLimitati0nsgt Monetary expansion may have negative effects on an already high in ation rate In particular expansion of money supply can galvanize the in ation expectation in the short run and may be re ected by the high in ation rate in the long run That is speculation on changes in exchange rates could lead to instability in foreign exchange markets gt In the severe situation in which the unemployment rate exceeds 11 annually in ation pressure in the markets will not be as high as expected gt The high in ation rate of 2004 resulted from the sudden rise in oil prices in the world market Considering the Philippines had kept stable in ation rate of around 3 until 2003 the current high in ation rate could be a temporary trend which will disappear sooner or later Thus monetary expansion will not affect the in ation expectation as much as we expect gt Since real private sector credit has continued to decline since 2001 supplying money to the market will not stimulate the in ation rate to a worrying level 2 Moderate Fiscal Expansion Recently the Philippines government has raised the tax rate rapidly in order to solve the chronic scal de cit problem For example power generation tariffs have been raised by over 50 VAT tax by 12 and corporate income tax by 35 As a result the disposable income of the Philippine people has decreased considerably In order to offset the negative effect of tax rate increase it is necessary for the government to use scal expansion policy moderately Fiscal expansion will help to alleviate the high unemployment rate to some extent And if scal expansion is used to improve the capacity of social overhead capital it will also have a positive and longlasting effect on the Philippines overall economy Even though the Philippines has very poor infrastructure such as unpaved roads and lack of electricity government expenditure has steadily decreased in percent of GDP since 1999 This retrenchment policy can be evaluated as successful in that it helped recover credibility from investors by reducing the scal de cit But it is evident that the scal policy has not helped to improve poor infrastructures and high unemployment rates St DDl DD2 2 S2 S3 3 b1 A l AA2 AAl Y Y1 Y2 Y3 A temporary scal expansion which does not affect the expected future exchange rate shifts the DD schedule to the right After the monetary expansion policy the economy is now at point 2 with exchange rate S2 and output Y2 The increase in government expenditure moves the economy to point 3 causing the currency to appreciate to S3 and output to expand to Y3 What economic forces produce the movement from point 2 to point 3 The increase in output caused by the increase in government spending raises the transactions demand for real money holdings This increase in money demand pushes the interest rate i upward Because the expected future exchange rate Se and the foreign interest rate i have not changed the domestic currency must appreciate to create the expectation of a subsequent depreciation just large enough to offset the higher international interest rate diiTerences in favor of domestic currency deposits ltLimitati0nsgt 0 Since the Philippines suffers from a fiscal deficit over time expanding government spending will deteriorate the current fiscal deficit and the credibility of government reform efforts regardless of the amount of government spending gt The current fiscal deficit resulted from a tax revenue decreaseTaxGDP ratio over the last seven years has declined But since tax revenue has been increasing recently expanding government spending will not deteriorate the fiscal deficit much Tax revenues were up 15 in 2005 compared to 2004 And the ongoing VAT reform is expected to yield 14 of GDP in revenue annually9 gt Government expenditure has steadily decreased in percent of GDP since 1999 As a result credibility in reform efforts will not be decreased by moderate and temporary expansion of government spending 0 Expansion of government expenditures will increase the national income and eventually deteriorate the trade deficit by increasing import gt If fiscal expansion is used together with monetary expansion policy as in the figure above trade deficit will be prevented to a considerable extent 3 Signi cant Improvement in the Philippines Economic Structure 0 Economy Structure Reform The Phillips Curve PC is a supposed inverse relationship between in ation and unemployment This curve indicates that it is very difficult to pursue these two policy objectives at the same time by showing the tradeoff relationship between in ation and unemployment In many cases this is true But as we see in figure 10 below we can not find the exact Philips curve relationship in the Philippines The Philippines unemployment rate has been always high regardless of the in ation rate This unusual phenomenon seems to result from the Philippines poor economic structures such as its uncompetitive industry structure and its vulnerable banking system The government should try to foster internationally competitive industries which have the potential to create a great deal of jobs And the government should also give priority to advancing the various legislative initiatives to develop domestic capital markets and to introduce transparent financial techniques from advanced countries 9 IMF Philippines 39 Sta Reportfor the 2005Arlicle IVConsultalion andPost Program Monitoring Discussion March 2006 18 1 This figure is drawn from IMF Intemational Financial Statistics data from 1997 to 2005 In atio n 12 nI39I 10 8 n a 6 n o 4 o 3 2 I l UnemploymentU 2 4 6 8 10 12 14 U ltPhilips Curvegt ltPhilippines Philips Curve 99 05 0 Political stability Political stability is inevitable in the Philippines economic development Considering its past political history the Philippines has suffered from frequent military coups and antigovemment demonstrations Such political instability has made the Philippines the country foreign investors avoid the most in Asia Many market analysts point out that the investment climate in the Philippines is perceived to be relatively inhospitable mainly because of frequent political turbulence Higher economic growth will require increases in investment and productivity Foreign direct investment currently at very low levels can play an important role in achieving both objectives 0 Transparency Transparency International TI has consistently ranked the Philippines among the worst one third of countries in terms of perceived corruption Moreover a deterioration in taX administration is regarded by many analysts as a major cause of the decline in the taxGDP ratio over the last seven years and hence of the current fiscal problem The authorities should keep in mind that the ability to attract investment requires building an effective government free of corruption and that corruption is one of the most serious obstacles to reducing poverty Annendix Figure 1 GDP Annual Growth Rate 1998 2005 and GNP Per Capita 2001 2005 1400 7 1200 7 6 1000 5 G3PBiions of r 4 392 600 3 G3P annual 400 7 2 change 1 0 ltng 9 F Q q x L i Sb W i 96 Per Capita GP US Ebllars UPer Capita GP US I39bllarsi 2002 2003 2004 2005 2001 Figure 2 Remittance from Overseas Filipino Workers 1999 2005 Oerseas Filipino Vibrker39 s Ren39ittences M i ons Dollars 12000 10000 U Oerseas Filipino Vibrker39 s Ren39ittencesM i nns Fhl 2r 3 e r r99 6 11 Sources are from IMF National Statistics Office of Philippines and Central Bank of Philippinesthe Ban gko Sentral ng Pilipinas BSP Figure 3 Government De cit 1998 2005 Cabvernment Fi nance Befi ci 1 M ions Pesos 0 50 100 000 D Gwer nnent Fi nance Defi ci t 150 000 ii lions Pesos 200 000 250 000 Figure 4 Trade Balance 1998 2004 Trade Bal anceM ions of LB hi I ars 3 Trade BalanceM ions of I Figure 5 Exchange Rate 1998 2005 Exchange FEteDol ar Peso D Exchange Rat i1 mi ar Pesm
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