Should we be worried about the fiscal deficit?

My fears were put to rest after I spoke to DTI Secretary Ramon Lopez during the monthly meeting of the Spanish Chamber of Commerce.
As my regular readers know, I have expressed my concern about the state of the country’s finances, particularly, our rising debt levels and fiscal deficit on numerous occasions.
For those unaware, a fiscal deficit occurs when the total revenues of government are less than its expenditures. As of the end of September, our fiscal deficit widened by a whopping 78% to P378.2 billion from just P213.1 billion last year. This is equivalent to 3% of GDP, which is the ceiling set by government.
There is still one quarter to go and if the current trend continues, we will likely overshoot the maximum tolerable fiscal deficit by a whole percentage point. Why is this alarming? Because the deficits will have to be financed by more debt.
As of the end of July, public debt already stood at P7,043 billion, representing approximately 41% of GDP. To increase our load of debt will erode this ratio.
There is nothing wrong with amassing debt, so long as you can pay it. Problem is, our Gross International Reserves (GIR) have been deteriorating too. GIR is the amount of foreign currency deposits, bonds, gold and special drawing rights held by a country. It serves as our buffer to pay for our imports and maturing obligations. From a high of $86.12 billion in September 2016, it plummeted to just $74.8 billion last October, the lowest in seven years.
At the heart of the problem is our trade deficit. Data covering January to September shows that imports rose by 16.2 % to $80.66 billion while exports slipped by 2.1% to $50.75 billion. This brought about a trade deficit of $29.91 billion, nearly twice the deficit registered last year.
The noxious combination of declining exports, ballooning imports, rising public debt and declining gross international reserves can be seen as a general weakening of the economy. It makes us more vulnerable to external shocks. This is the reason for my unease.
NECESSARY AND TEMPORARY
If anything, Secretary Lopez put things in perspective and this helped assuage my doubts about the economy’s health.
On spiking imports and consequent widening of the trade deficit, Sec. Lopez assured us that this is not only necessary, it is also temporary.
It is necessary because a large chunk of our imports are steel and cement, both vital components to government’s infrastructure program. Demand for cement is now at some 28 million tons a year, nearly twice the level between 2000 and 2010. Demand for steel has tripled to 9.82 tons per year. This just goes to show that infrastructure projects are well under way and that capital formation is on the rise.
Import statistics also show an influx of capital equipment. This indicates that more factories are being built, all of which will contribute to the economy’s productivity and export earnings.
The gaping trade deficit is also temporary. It will begin to ease once the US-China trade war cools off and new factories presently under construction come on line and begin their export operations.
On foreign direct investments, last year, the country realized $10.2 billion worth of FDIs, the highest intake ever recorded. In the first eight months of 2018, FDIs already stood at $7.4 billion, 31% higher than the same period last year. The Secretary is confident that $12 billion in FDIs can be realized in 2018. Exports are bound to catch up given the number brick and mortar factories presently being built.
While the Philippines has largely been dependent on electronics to drive its exports, the mix is becoming increasingly diverse. Emerging industries are auto parts, aerospace components, design-based furniture and garments and chemicals, said the Secretary.
It is not likely that we will realize a balance of trade surplus in the medium term. The deficit will persist for as long as the catch-up in infrastructure continues. What we can reasonably count on is its gradual narrowing.
As for the fiscal deficit that has already hit its ceiling last September, DBM Secretary Ben Diokno is of the opinion that it will not deteriorate further in the 4^th quarter but will in fact improve. He sees importation and expenditures easing as government has already front-loaded spending in the first nine months of the year. I still have my doubts, but time will tell if Sec. Diokno is right.
REASONS TO BE OPTIMISTIC
If there is anything to be optimistic about, it is the manufacturing sector, declared the Secretary. The country is in the midst of a manufacturing resurgence after a deceleration that lasted three decades. From 2010 to 2017, manufacturing clocked in an average growth rate of 7.6%, outpacing the growth of the service sector. This shows that we are on track towards industrialization.
No surprise, food and beverage manufacturing lead the charge in both size and growth rates. This is due to our enormous domestic market and to a smaller degree, international demand. Also on the fast track are domestic appliances, chemical products, auto parts and mineral products.
Tourism is another bright spot. Sec. Lopez and I both agree that tourism will play an increasingly important role in the economy for its ability to generate foreign exchange instantaneously. It is unlike manufacturing plants that require a two year gestational period. Revenues from tourism can offset the fiscal deficit.
There is no denying the pent-up demand for inbound travel to the Philippines. What has held us back is the lack of provincial airports and lack of roads to connect tourist destinations.
The good news is that these impediments are slowly being addressed. Soon to join the newly inaugurated airports in Mactan, Lagundian, Puerto Princesa and Iloilo are new gateways in Panglao (to be inaugurated this week), Clark and Bacolod. In terms of road connectivity, the DPWH is now constructing 6,480 kilometers of roads within 49 tourism clusters across the country.
Tourism arrivals from January to August this year registered an 8.5% growth to 4.9 million visitors, despite the closure of Boracay. The country will likely surpass its target of 7.2 million visitors and will generate some $9.4 billion in revenues. The goal is to generate $17.7 billion on the back of 12 million visitors within three years.
As far as the BPO industry goes, Sec. Lopez assures the group that the BPO industry will continue to expand despite the widespread adoption of artificial intelligence. The thrust for the Philippines is to be the operator and maintenance provider of artificial intelligence across the globe.
As far as inflation goes, we should see some improvement this November, assures the Secretary. Inflation should ease to between 5 to 6%, from a high of 6.7%. With the tariffication of rice fully implemented and money supply restricted with successive interest rates hikes, our economic managers believe that the worse is over. Inflation for next year is seen to hover between 3.5 to 4.3 percent.
MISSING PIECE
If Sec. Lopez’ statements are anything to go by, it can be said that the economy is on an even keel, notwithstanding fiscal deficit pressures.
Still, I argue, the economy is not running on all cylinders. While the economy is growing apace driven by domestic consumption and government spending, the equation is not complete without exports driving the economy too. Only with the three components in place can we truly generate wealth.
The fact that we are in the midst of a manufacturing resurgence is a good sign. It means that merchandise exports will grow in step. However, the 7.6% growth of manufacturing is not enough. Growth needs to reach 15 to 20% if we are to approximate the export levels of our ASEAN neighbors.
Consider the difference. Philippine merchandise exports amounted to $68.71 billion last year. Compare this to Thailand’s $237 billion, Vietnam’s $214 billion, Malaysia’s $176 billion and Indonesia’s $169 billion. The Philippines has a lot of catching up to do.
The fly to the proverbial ointment is the restrictive provisions of our Constitution in as far as foreign investors are concerned. The Philippines has the most restrictive investment environment in ASEAN — no surprise, it also has the lowest shares of FDIs among the ASEAN 6.
A more liberal investment climate translates to more FDIs to build plants and factories. This redounds to higher export earnings.
Earlier this month, five investments areas were released from the foreign investment negative list. They consist of businesses related to Internet services, higher education, training centers, adjustments and lending companies and investment houses. While welcome, I don’t think this will make a significant dent in our FDI performance.
What we need is to liberalize such industries as land development (when land is owned), Build-Operate & Transfer deals, and retail operations above $200,000 capitalization. The 40% equity restriction on Filipino companies and land ownership must be rationalized too. Only then can we be regionally competitive.
These restrictions are embedded in the massively flawed 1987 Constitution and it would take an act of Congress to undo.
The story of the Philippines is still being written. While the economy is fraught with defects, we can rest in the fact that organizations like the Spanish Chamber of Commerce stay vigilant and keep our economic managers on their toes. We can also be assured that there are competent technocrats like Sec. Lopez who champion reforms.
 
Andrew J. Masigan is an economist