ON July 23, my colleague Christine Tang and I were asked by GlobalSource Partners New York* to do a teleconference call with our international subscribers on the topic in the headline. I am pleased to share with readers the transcript of that call. Apologies, this will have to be in two parts. The second installment will be on the risks to this cautiously optimistic scenario, and some political analysis — what the President will likely do with his abundant political capital and the odds of policy continuity post 2022.
I will talk about the following key points:
1. First, the economy under President Duterte, which is doing well in terms of economic growth and stability. The reform agenda is also progressing better than expected.
2. Second, the administration’s Build, Build, Build program, intended to usher in a “Golden age of infrastructure.” The Gold (medal) is aspirational, but efforts may yet earn the administration a Bronze.
3. Third is an assessment of economic prospects in the next three years under President Duterte. I think growth will be resilient at 6%, or even 6.5%, but will be hard to sustain if higher than that.
4. Finally, tail risks and politics.
Let’s start with the economy under Duterte: so far so good.
The President’s economic management style from Day 1 has been to give his economic managers a free hand. Led by his finance secretary Carlos Dominguez III, the economic team hit the ground running and announced a 10-point agenda that hewed closely to the policies, programs and projects of past administrations. The team had its challenges along the way, for example the delay in the passage of this year’s budget and last year’s inflation spike but by and large, the economic team has been successful at maintaining macroeconomic stability, i.e., keeping growth above 6% and steering inflation back within target, it is below 3% now.
Many have also noted that under this administration, the masses have shared in economic growth, with surveys showing a lower number of people identifying themselves as poor, unemployment rates continuing to fall and the quality of jobs improving. Reasons for this include income tax cuts implemented by this administration as well as a number of social programs that have increased households’ disposable income, e.g., free college tuition, higher pensions, conditional cash transfers and universal health care. Although we and other analysts have flagged the rising fiscal costs of these and other subsidy programs, so far, the fiscal burden has been limited.
The other notable achievement of the economic team is the passage and implementation of difficult economic reform measures that have earned the sovereign credit a BBB+ ratings upgrade from S&P. On the fiscal side, the TRAIN (Tax Reform for Acceleration and Inclusion) law for example, which replaced losses from lower personal income tax with higher consumption taxes especially on oil, raised the tax effort by 1% of GDP in its first year of implementation. These revenue inflows have helped to fund higher public spending on social services and infrastructure while keeping the budget deficit at around 3% of GDP, a fiscally sustainable level, per the IMF.
Other reform measures include the game changing rice tariffication law, a reform three decades in the making that has brought down rice prices, as well as the anti-red tape law, the BSP Act, National ID and the Bangsamoro Basic Law. The next stage challenge of implementing these reform measures as designed is underway, and the political will to do so seems to be there based on the explicit statements of the President during his State of the Nation Address.
The one activity that has defined this administration’s economic program to date is the Build, Build, Build infrastructure program, my second discussion topic.
Historically, over the last three or four decades public spending on infrastructure averaged only around 2% of GDP, a far cry from the average of 5% of our neighbors. The failure to invest is showing badly in congestion on roads, rails, sea ports, air ports. Slow approval processes are also beginning to affect the power sector which has been privatized. Failure to develop water sources by government has also caused water shortages in Metro Manila.
The last administration managed to raise infrastructure spending but only up to 3% over a six-year period. What the Duterte administration did was to raise spending to 5% of GDP three years into its term. And, through an ambitious infrastructure program, it intends to ramp up spending to 7% of GDP by 2022, the end of its term. This, economic managers say, is consistent with the target 7-8% GDP growth.
But I doubt that they can achieve these targets nor do I think it desirable to ramp up infrastructure spending so quickly. Experts I talked to question not only what makes up the 5% of GDP spending but they tell me that the quality of the projects pursued so far are not all growth enhancing. Many involve maintenance works on existing facilities some of which are superfluous. IMF estimates also show low efficiency of public investments in the Philippines, suggestive of large leakages.
My take is that is that if government could only maintain infrastructure spending at the current 5% of GDP over the medium term, that would already be a big achievement, especially if that 5% is spent on good projects that have high economic returns.
In any event, at 5% of GDP, BBB will be an important driver of GDP growth in the next three years, although all the construction activity is adding to chokepoints to economic growth in the short-term and it will take perhaps two more years for us to feel the decongestion effects of ongoing projects.
This brings me now to my third discussion point, the resilience of a 6% economic growth for the Philippines.
First, let me go over the structural factors underpinning the 6% economic growth rate. Philippine GDP trend growth rate has risen from an average of about 3% in the 1990s to 4-5% in the 2000s, to above 6% from 2010 to 2018. There are three reasons behind this rising trend growth.
One is demographics. The country has a young population, over 60% are in the working age group and this number will grow by 60% over the next two decades. The growth impact of this is evident in resilient remittances and the expansion of the BPO sector that have fueled domestic consumption and raised demand for retail trade services, financial products, and a real estate boom.
The second factor is the combined impact of past reform efforts on total factor productivity. Due to the reforms beginning in the 1980s (trade and foreign exchange liberalization, opening up of telecommunications and financial sectors, privatization of power), the contribution of total factor productivity to economic growth has grown from only 0.5 ppt in the 1990s to over 2 ppt this decade (Source: BSP).
Third is the growth of the middle class, which we think will continue to feed the consumer sectors. The rising importance of the middle class is an upshot of decades of sustained high remittance and BPO sector growth, both continuing but maturing and thus expected to grow at lower single-digit rates. A recent phenomenon that has taken up the slack left by slowing remittance and BPO growth rates is online gambling. The emergence of this sector has seen an estimated 200,000 Chinese workers moving to the Philippines, pushing up demand in real estate, construction, retail trade, etc. Young, single, and earning roughly $12,000 a year, this group is adding to middle class demand with spending potential approaching 1% of GDP.
(To be continued.)
Romeo L. Bernardo was finance undersecretary during the Cory Aquino and Fidel Ramos administrations.