Salceda Briefing Paper

America sneezes, Asia catches pneumonia, RP gets a flu? A briefing paper for PGMA by Governor Joey Salceda 12 November 2008 GLOBAL TRENDS Contrary to most impression, developing economies particularly Asia will principally bear the brunt of the economic slowdown cum financial crunch. Their stock markets are starting to indicate that grim prospect. Global Equities Markets Performance US Markets Nasdaq S&P 500 DJIA

2007 Price High 2,861.5 1,576.1 14,198.1

Current Price 1,552.0 876.8 8,379.0 Average

Other Major Markets Japan (Nikkei) France (CAC) Germany (DAX) Australia (All Ordinaries) U.K. (FTSE)

18,295.0 6,168.2 8,151.6 6,873.2 6,751.7

7,649.1 3,193.8 4,295.7 3,869.4 3,883.4 Average

Asian Markets China (Shanghai Comp) Hong Kong (Hang Seng) Singapore (STI) India (BSE Sensex) Indonesia (JCI) Korea (Kospi) Taiwan (Taiex) Thailand (SET) Philippines (PSEi) Malaysia (KLCI)

6,124.0 31,958.4 3,906.2 21,206.8 2,838.5 2,049.6 9,859.7 924.7 3,896.7 1,524.7

1,932.4 12,618.4 1,600.3 8,701.1 1,244.9 938.8 4,579.6 432.9 1,953.5 859.1 Average

%Chg from Peak -45.8% -44.4% -41.0% -43.7% -58.2% -48.2% -47.3% -43.7% -42.5% -48.0% -68.4% -60.5% -59.0% -59.0% -56.1% -54.2% -53.6% -53.2% -49.9% -43.7% -55.8%

Source: Bloomberg While a repeat of the 1929 Great Depression spooks many, if it comes to pass, chances are it would be more of a Great Asian Depression, ex-Japan. The higher you climb, the harder you fall; Asia is a high-beta asset in the world market. And as China led on the way up, it will lead the road down with its index at -68%, the worse in the world. As Asian assets benefited almost one-way from two major shifts of monetary expansion- post Plaza Accord and the 2003-2007 US easy money [partly underwritten by Asia’s fixation with dollar reserves], so it must now contend with their one-0way backflow. And as the stock markets suggest, the Philippines is 2nd only to Malaysia as being least affected since it benefited from these inflows in lesser magnitude. But, they will not escape the brunt and the Philippines will at least enter a period of severe external financial stress.

Dim and dimmer

Source: IMF

6

The current bailout blow-out has spread from banks to non-bank financial institutions in the G7 to their manufacturing firms and now to entire economies- mostly in emerging Europe and Latin America. Already, 7 countries have approached the IMF for lifeline- Ukraine- $16.4bn, Poland - $15bn, Hungary- $25bn, Iceland- $2bn, Pakistan- $15bn and Brazil has alerted the IMF. The demand for assistance has already to ballooned $70bn biting off 30% of the IMF’s armory. The list is likely to get longer. When the full crunch comes to Asia, the IMF’s warchest possibly would have been so expended and Asia's own reserves emptied. Life is unfair- the least culpable is invariably the most affected. Healthy reserves thus far underwrite pervasive complacency in the region. But, as they are drawn down to meet capital withdrawals amidst export slowdown; this would upset the policy composure of Asian economic authorities. And it would be sooner than later. As the chart below shows, the Philippines did better than its Asean peers with cumulative net inflows from 1999 to March 2008 versus net outflows for Thailand, Malaysia and Indonesia. Conversely, being net inflow beneficiary, it would be most vulnerable to a reversal to outflow. Such reversal could be triggered by the sale of Philamlife by AIG for $1.5bn wiping out the entire BOP surplus projection for 2007. This is also becoming evident in China that is starting to run down their reserves (US$1.9trn) to fund local acquisition of foreign-owned enterprises.

Chart 1: Cumulative financial account flows into ASEAN economies since Q1 1999

lows into ASEAN economies since Q1 1999

USD bn

Rising cumulative inflow Rising cumulative outflow

Source: CEIC, Haver, UBS

Comforted by the adjustments provoked by the Asian financial crisis, analysts conveniently overlook the underlying risks of Asia since reforms would have relatively immunized the region from external risks. But these adjustments were smoothened by two factors- US Fed sustained a loose monetary policy and the global economy was enjoying robust expansion, thus pre-empting a more cathartic adjustment towards a cleaner slate. And the Asian bravura must reconsider two factors (1) heavy market dependence on OECD markets rising to 47% of GDP and (2) inordinate dependence on foreign capital, (a) equity- both portfolio and direct equity and (b) debt – both bank credit and spontaneous debt markets. So much for decoupling. While weak external demand would be a bigger problem in the medium term, financing difficulties have a more immediate and debilitating effect which could precipitate a forex crisis region-wide and make long term economic adjustments more painful. And this has been the motivation for the Philippine insistence on a quickdispensing stabilization fund at the latest ASEM in Beijing. Portfolio outflows constitute the most apparent and immediate risk. And they have already shaken down regional stockmarkets and cancelled many capital exercises. Yet, a dramatic reversal in direct capital flows, as a result of the financial meltdown and global economic contraction, is a significant risk for Asia that has been less universally acknowledged- not just a slowdown in capital inflows, but a reversal resulting in net resource outflows at a time when they are needed to hold up domestic demand. Whereas before only footloose portfolio flows were seen to be destabilizing, even FDIs now pose an even larger liability as parent companies are forced by the credit squeeze in their home economies to demand more dividends and capital repatriation.

The other source of capital - debt- that could compensate equity outflows is also being denied to emerging economies. The Bank of International Settlements reported that cross-border lending collapsing by US$1.1trn in 3Q 2008. Formal bank credit via loans has largely financed private investments in Asia. The credit squeeze is being felt mainly through an acceleration in FDI repatriation. International commercial banks even if soon recapped would take some time to get their hands on the sovereign business and would be so risk-averse to do so after having been burnt in lending to governments during the petro-dollar boom in the late 1970s. This is most revealing on the Philippines which is the most dependent on ROP financing. Spontaneous credit markets have yet to resurrect from the collapse of big 5 investment houses and many of their major fund clients and the consequent loss of institutional memory and informational capital, the dynamo of capital market efficiency. The crux of the global crisis is the structural imbalance between a glut of financial savings and a deficit of real resources. On the individual level, we ordinarily think of savings deposits as a good thing since they mean postponed consumption, say of one more tree not being cut down, yet they still represent a claim to a future utilization of natural resource and worse they merely bankroll the current use of that tree by another! On the macro level, developing nations have run large persistent surpluses and amassed huge pool of reserves. While these meant postponed consumption, these were earned by exploiting their natural resources and underpricing them to flood markets of developed economies with cheap goods. And, these reserves spontaneously financed the consumption, thus the foreign payments deficit of the reserve currency country principally the US who were happily creating new money at cheap interest rates. And this triggered a protracted regime of procyclical monetary indulgence (negative real interest rates) and fiscal extravagance (rising deficits), largely by developed countries. They were earned by using up and even wasted so much non-renewable resources (e.g. war on terror) beyond the capacity of the earth to regenerate. Firms skimped on research for higher EPS even as they were already operating on the upper limits of the productivity frontier (unlike the 1990s IT revolution or the 1850’s industrial revolution).

Chart 1: Assets Under Management

60

40

20

0

Source: UBS FX Strategy

Easy money bloated the financial economy of equities, hedge funds, derivatives beyond the capacity of the real economy to earn [also, society’s capacity to learn?]. As of March 2008, assets of G10 asset managers stood at $80trn dwarfing the $6trn assets of central banks and oil-rich Mideast. Initially, this fundamental disequilibrium created asset and commodity price overshoots on the way up and now triggers an asset recession as they revert to mean. For starters, let’s unwind US$60trn universe of credit default swaps and its satellites of options and derivatives. Such adjustments would have convulsive impacts.

Chart 2: Financial Sector Assets

60

30

0

Source: UBS FX Strategy

And we are now correcting such long term disequilibria just when the global economy is cyclically bound for a slowdown. It would be tougher to hold back the onset of a recession in the middle of violent financial and structural adjustments particularly in reserve currency economies. A disorderly adjustment is therefore more likely and it promises to be quite painful for poor countries and especially for the poor in those countries. But the greater pain is really being exacted by an intergenerational transfer of consumption/purchasing power from the present to the future [read: climate change] During the 1930 depression, natural resources were relatively more abundant, a critical difference that has largely been overlooked in devising current solutions. One would expect the financial meltdown in US and EU, with the least damage to Japan, to reduce their relative dominance of global financial resources. Instead we are seeing a growing reconcentration into reserve currency economies particularly into the control of their governments. First, unlike Asia ex-Japan, the dollar, euro and yen enjoy the unique and insuperable benefit of being reserve currencies and thus their authorities can print money at low nominal cost (negative real interest rate) to replenish massive capital decimated by the financial meltdown and finance the resulting deficit of their stimulus programs. Second, depositors, more wary of their country’s financial institutions, would rather lend to their national governments. In turn, treasuries of governments redeploy these resources to their “systemically significant institutions”domestic banks and now even industries. The deleveraging adjustment is being made less painful by transferring the leverage from the private sector to the government

Third, making matters worse, some financial policies of developed economies like full deposit guarantees are actually driving capital out of weaker economies. And such beggar-thy-neighbor move has particularly been a significant factor in the peso weakness as Philippine authorities struggle to catch up in the deposit insurance game. Fourth, portfolio funds have been going back to home as a UBS research suggests. There is also increasing repatriation of FDI via higher dividends or capital withdrawals. Fifth, even if G10 banks are recapped, they are mostly in the midst of derisking. And even if lending is restarted, it can only be sustained by private depositors who are just as risk-averse preferring instead to buy government securities.

Chart 3: US Asset Managers

25.0 20.0 15.0 10.0 5.0 0.0

Source: UBS FX Strategy

Chart 4: Foreign Assets As Share Of Total Assets, Mutual Funds

60%

60%

50%

50%

40%

40%

30%

30%

20%

20%

10%

10%

0%

0%

Source: UBS FX Strategy

Thus, the dollar has apparently retaken its safe haven status [although depreciating against the yen as carry trades are unwound while appreciating against the euro]. This permits the US to simultaneously print new debt and reduce Fed rates while Treasury rates are falling even with expanding public deficit with serial stimulus program despite mounting public debt from 21% of GDP in late ‘80s to 121% (Fannie/Ginnie included). Of course, much of that financial muscle [new money/new debt] will be earmarked by national governments and monetary authorities, particularly in the US, towards bailing out their domestic constituents- banks and homeowners, industries and consumers. G7 governments are likely to look inward before looking elsewhere. In any case, even the $700bn TARP will take time to logistically deploy to bankable end-users. In the meantime, emerging economies are being denied of spontaneous credit and are increasingly pushed into the arms of the IMF whose warchest of $250bn is dwarfed by the US$7.8trn bailouts by US/EU ($4.5bn in debt assumption and $3.3trn in new money) and US$986bn by Asia (US$586bn- China, US$250bn- Japan and US$150bn- Korea) to avoid an economic crisis despite their historical reluctance with the procyclical tendencies of the multilateral institution. . THE PHILIPPINE CASE The external risks to the Philippines real economy can be summed up: •

•

Exports – 36% of GDP (US$57bn) vs 47% average for Asia – 17% direct to the US but indirect adds 18% for 35% – Export slowdown is global, so aggregate national exposure and product mix are more important OFWs- 12% of GDP (US$16bn)

– – –

•

•

•

“Investment content” is most at-risk reflected in rising default rates and deposit forfeitures reported by property companies Recent deployment growth has offset OFW investment inflows Jobs cuts and income stagnation plus investment repatriation likely to drive a 12% fall in 2009

Tourism- 3% of GDP (US$4.5bn) – Rising personal bankruptcies / bad mortgages – 92% from non-Asean BPOs- 3% of GDP (US$4.5bn) – Lost business from some big-ticket principals especially in the financial sector – Higher vacancy as office space completed 501,000sqm in 2008 from 330,000 in 2007 Impact on overall business and consumer confidence

Dim and dimmer

Source: IMF

6

While Philippine export to GDP is lower than Asia’s 47%, the 36% exposure expands by another 12% from higher OFW business, actually the country’s biggest net dollar earner. And even Philippine tourist traffic is most exposed to the advanced economies.

RP most exposed to non-Asean traffic Tourist arrivals in ASEAN as of 14 March 2007 in thousand arrivals Country The Philippines Myanmar Viet Nam Cambodia Thailand Singapore Indonesia Lao PDR Malaysia Brunei Darussalam ASEAN

Total 13,394.6 2,966.3 17,364.3 6,269.3 68,019.3 48,203.6 27,428.4 4,791.2 81,681.6 2,921.1 273,039.6

2001-2006 % to Total IntraExtraIntraExtraASEAN ASEAN ASEAN ASEAN 892.9 12,501.7 7% 93% 304.8 2,661.4 10% 90% 2,211.1 15,153.2 13% 87% 975.8 5,293.5 16% 84% 17,080.2 50,939.0 25% 75% 17,376.6 30,827.0 36% 64% 11,998.9 15,429.5 44% 56% 3,483.8 1,307.4 73% 27% 62,561.7 19,119.9 77% 23% 2,571.5 349.6 88% 12% 119,457.4 153,582.3 44% 56%

25 20 15 10 5 0 5 10 15 20 25

Source: BSP Q32008 Inflation Report 2

The financial risks, however, pose more immediate and increasingly apparent concerns. In our preoccupation with the financial collapses elsewhere, there is less analytical attention to the BOP accounts that already experienced a US$450m outflow in September, the highest in four years while total reserves (GIR + swaps) falling by $9.1bn from its 2008 peak.

Table 1: Indicators of pressures on ASEAN currencies Singapore Thailand Malaysia Indonesia Philippines Change in exchange rate (currency per US dollar) from 4.7% 3.5% 8.2% 17.0% 19.7% 31 Dec 2007 to 28 Oct 2008 Change in FX reserves + forward reserves since + 14.9bn + 10.5bn + 13.1bn + 0.2bn* - 4.2bn December (assuming forward reserves unchanged in Sept) Change in FX reserves + forward reserves from peak - 34.8bn - 23.6bn - 32.4bn - 3.5bn* - 9.1bn (assuming forward reserves (Apr-08 peak) (Mar-08 peak) (Apr-08 peak) (Jul-08 peak) (Feb-08 peak) unchanged in Sept) Decline in FX reserves as a % -13.0% -17.8% -22.4% -5.7% -18.6% of peak reserves Current account balance, 15.4% 3.8% 13.6% 1.9% 2.2% Q1 2008 (% of GDP) Current account balance, 13.5% -1.4% 19.6% -1.1% 2.0% Q2 2008 (% of GDP) *Note: data on forward reserve position is unavailable Source: UBS

More worrisome, there are fewer inflows and fewer outflows in our capital accountsFDIs, portfolio investments and other investments (basically trade receivables/payables). It is likely that this will soon move up into the income accounts- a one-way negative for the Philippines which relies on OFW remittance for US$16bn pa. Most susceptible is the investment content (proof- property sales) of this flow. Increase in deployment has, however, obscured or delayed this adjustment. Table 2: International investment position (2007) % GDP Total assets FDI assets Portfolio assets Portfolio assets: equities Portfolio assets: bonds Other assets (bank loans/trade credit etc.) Official reserve assets Memo: Assets net of FDI

Singapore Malaysia Philippines Indonesia 521.5 115.7 46.3 21.8 100.7 30.0 3.8 0.1 116.6 7.9 4.6 0.7 71.5 6.5 0.1 0.1 45.1 1.4 4.4 0.6 207.8 25.3 14.6 7.8 96.5 52.3 23.3 13.2 420.8 85.7 42.5 21.7

Thailand 59.6 3.3 6.0 1.3 4.7 14.1 35.6 56.3

Total liabilities FDI liabilities Portfolio liabilities Portfolio liabilities: equities Portfolio liabilities: bonds Other liabilities (bank loans/trade credit etc.) Memo: Assets net of FDI

429.8 138.0 102.6 91.2 11.4 189.2 291.8

118.5 39.5 53.1 35.0 18.1 25.6 79.0

65.2 13.8 23.2 7.0 16.2 28.2 51.4

56.4 13.7 16.4 9.6 6.8 26.4 42.8

83.1 38.6 25.9 23.0 6.3 18.3 44.5

Net assets Memo: Net assets ex-FDI

91.7 129.0

-2.8 6.7

-18.9 -9.0

-34.7 -21.1

-23.5 11.8

69.3% 90.0%

92.1% 237.4%

121.1% 268.3%

197.3% 501.6%

79.3% 219.7%

0.9%

4.5%

2.9%

1.1%

2.4%

0.8%

30.2%

14.5%

25.5%

10.3%

Non-FDI assets against non-FDI liabilities: Non-FDI liabilities/(assets ex FDI) Non-FDI liabilities/(assets ex FDI and reserves) 1% change in portfolio assets as a % of daily FX market turnover 1% change in portfolio liabilities as a % of daily FX market turnover Source: UBS, Haver, IMF

Such net resource outflows would now similarly require a tighter monetary policy just when the increase in GIR from $22bn to $36bn prompted M3 growth of +26% in 2006-2007 despite valiant effort to sterilize dollar inflows via swaps/NDFs.

GIR to GDP Ratio (since devaluation) Year

GIR (US $m )

P

1999 2000 2001 2002 2003 2004 2005 2006 2007 Mar-08 Jun-08 Sep-08

15,147.31 15,062.82 15,692.23 16,364.76 17,063.06 16,227.91 18,494.36 22,966.72 33,751.05 36,624.01 36,712.28 36,691.68

GDP

P/$ Rate

(current, Pm ) (end of period)

GDP (US $m )

73,845 67,097 3,631,474 51.4040 70,646 3,963,873 53.0960 US$14bn increase in GIR 74,655 4,316,402 55.5690 77,676 4,871,555 56.2670 86,579 5,444,039 53.0670 102,588 6,032,835 49.1320 122,788 6,648,245 41.4010 160,582 7,446,034 41.8680 177,845 7,446,034 44.7560 166,370 46.9170 7,446,034 158,707 0.0019% 2,976,905

40.3130

3,354,727

49.9980

GIR/GDP 20.51% 22.45% 22.21% 21.92% 21.97% 18.74% 18.03% 18.70% 21.02% 20.59% 22.07% 23.12%

Source: BSP for GIR & P-$ Exchange Rate NSCB for GDP current

Simply, excess pesos or local currencies that had been created by those inflows must now be proportionally drained out or more painfully a currency devaluation to reestablish price equilibrium.

Broad Money Liabilities (M3) Oct-06 Nov-06 Dec-06 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07

16.7 19.3 22.7 21.9 22.0 24.7 26.1 20.5

15.0

10.0

Entry of virus?: Pesos created by new forex inflows must now be proportionally contained with forex outflows!

5.0

-

Source: BSP

19.4 18.7

Balance of Payments Item CURRENT ACCOUNT

January – June 2007 /r 2008 /p

Growth Rate (%)

3,580

1,707

(52.3)

(2,859) 28,043 30,902

(5,751) 30,160 35,911

(101.2) 7.5 16.2

Goods Credit: Exports Debit: Imports Services Credit: Exports Debit: Imports

(3,167) 24,169 27,336 308 3,874 3,566

(6,404) 25,156 31,560 653 5,004 4,351

(102.2) 4.1 15.5 112.0 29.2 22.0

Income Credit: Receipts Debit: Disbursements

(407) 2,468 2,875

(68) 3,256 3,324

83.3 31.9 15.6

Current Transfers Credit: Receipts Debit: Disbursement

6,846 7,034 188

7,526 7,727 201

9.9 9.9 6.9

144

1,197

731.3

(6) 57 63

30 57 27

600.0 0.0 (57.1)

150 (1,415) 3,348 1,933

1,167 742 71 813

678.0 152.4 (97.9) (57.9)

2,347 516 2,863

(191) (2,101) (2,292)

(108.1) (507.2) (180.1)

(150) (41) (191)

(27) (191) (218)

82.0 (365.9) (14.1)

(632) 3,332 2,700

643 (1,663) (1,020)

201.7 (149.9) (137.8)

(537)

(970)

(80.6)

(537)

(970)

(80.6)

Goods and Services Exports Imports

CAPITAL & FINANCIAL ACCOUNT Capital Account Credit: Receipts Debit: Disbursements Financial Account Direct Investment Debit: Assets, Residents' Investment Abroad Credit: Liabilities, Non-Residents Investments

Portfolio Investment Debit: Assets, Residents' Investment Abroad Credit: Liabilities, Non-Residents Investments

Financial Derivatives Debit: Assets, Residents' Investment Abroad Credit: Liabilities, Non-Residents Investments

Other Investment Debit: Assets, Residents' Investment Abroad Credit: Liabilities, Non-Residents Investments

Change in Commercial Banks' NFA NET UNCLASSIFIED ITEMS

OVERALL BOP POSITION

3,187

1,934

(39.3)

Aggregating capital flows from 1999-2007, the Philippines would have a net liability position of US$13.749bn, principally in $14bn in net portfolio inflows, -$10bn in export receivables and $10bn in FDI inflows. However, if we only consider cumulative inflows then our liability position would jump to $33.5bn particularly if residents’ investments abroad of $19.8bn (principally export receivables) are not as easily pulled back.

1

PHILIPPINES: BALANCE OF PAYMENTS (in US$m) CAPITAL AND FINANCIAL ACCOUNT

Capital Account

2007 r/

Total (1999-2007)

2889

13749

24

663

Credit:

Receipts

108

1049

Debit:

Payments

84

386

Financial Account

2865

Direct Investment

-514

9307

Debit: Assets, Residents' Investments Abroad

3442

4799

Credit: Liabilities, Non-Residents'

2928

14106

4382

14284

Debit: Assets, Residents' Investments Abroad

-813

4728

Credit: Liabilities, Non-Residents'

3569

19012

-288

-544

Debit: Assets, Residents' Investments Abroad

-170

-924

Credit: Liabilities, Non-Residents'

-458

-1468

-715

-9961

Debit: Assets, Residents' Investments Abroad

4852

11362

Credit: Liabilities, Non-Residents'

4137

1401

Investments in the Phil.

Portfolio Investment

Investments in the Phil.

Financial Derivatives

Investments in the Phil.

Other Investment

Investments in the Phil.

Chart 2: Cumulative financial flows in the Financial Ac balance of payments starting from Q1 1999

USD bn Rising cumulative inflow

Trends suggest that, soon, this would inevitably scale up to the trade accounts- fewer exports, fewer imports. August imports of inputs to electronics, its principal export commodity, were down 27%. No incipient signs of protectionism, just normal human behavior- that firms are owned by real people who have nationalities. No place like home. Like ships taking shelter to the shore during stormy seas. This will then turn full circle into the financial sector lower trade leads to less trade finance which exacerbates deleveraging. “Back to the caves” leads to “back to under the mattress”. To offset these equity outflows, Philippines turns to credit given anticipated weakness in other forex sources- exports, OFW investment flows, BPOs, tourism. And it heavily relies on the sovereign bonds whose share doubled from 22% of total debt in 1999 to the current 42% while multilaterals have fallen to only 5% of total external liability. In absolute amount, sovereign bonds have grown 6-fold from P200bn to P1.15trn (July at P947bn plus 20% depreciation). In fact, 73% of the increase in foreign debt stock was from sovereign bonds. The Philippines is the 2nd biggest bond issuer in Asia in Japan, making it the most vulnerable to the lagged impacts on the financial meltdown. Already, the Philippines is feeling the credit crunch with external borrowings in the first nine months have been curtailed from P103bn in 2007 to P51bn in 2008 versus P173bn fullyear foreign debt service, P111bn in principal and P62 in interest.

NG Debt Service 1999-2008 (in Pm) 1999

2000

2001

2002

2003

2004

2005

2006

2007

2008*

TOTAL DEBT SERVICE

205,396

227,843

274,439

357,959

469,990

601,672

678,951

854,374

614,069

610,300

Interest Payments Domestic Foreign

106,290 74,980 31,310

140,894 93,575 47,319

174,834 112,592 62,242

185,861 119,985 65,876

226,408 147,565 78,843

260,901 169,997 90,904

299,807 190,352 109,455

310,108 197,263 112,845

267,800 157,220 110,580

299,500

Principal Payments Domestic Foreign

99,106 61,552 37,554

86,949 45,429 41,520

99,605 54,038 45,567

172,098 80,944 91,154

243,582 147,322 96,260

340,771 222,405 118,366

379,144 253,492 125,652

544,266 380,939 163,327

346,269 284,017 62,252

310,800

6.90%

6.79%

7.56%

9.03%

10.89%

12.35%

12.47%

14.16%

9.24%

As % of GDP

Spreads have spiked to almost 630bps or a nominal interest rate of 8.9%, although partly due to the fall in the base rates (US Treasury Notes). Foreign borrowings of the national government are likely to be constrained as global bond markets are likely to be less accommodating. Only a reflow of our annual gross repayments to multilaterals and bilateral, RP being a net payer since 2004, is most reliable and accessible. Multilateral influence over the course of domestic economic policy will resurge with a vengeance, hopefully more benign.

NG Foreign Bonds 1995

2000

2001

2002

2003

2004

2005

2006

2007

2008

Change 1995-2008

TOTAL

1,158,622 2,166,710 2,384,917 2,815,468 3,355,108

3,811,954 3,888,231 3,851,506

3,712,487 3,966,069 2,807,447

Domestic Debt NG Direct Assumed

718,395 1,068,200 1,247,683 1,471,202 1,703,781 678,007 1,049,083 1,233,825 1,462,950 1,701,484 40,388 19,117 13,858 8,252 2,297

2,001,220 2,164,293 2,154,078 1,998,926 2,161,999 2,151,784 2,294 2,294 2,294

2,201,167 2,338,569 1,620,174 2,198,873 2,336,275 1,658,268 2,294 2,294 -38,094

Foreign Debt NG Direct NG Foreign Bonds Assumed

440,227 1,098,510 1,137,234 1,344,266 1,651,327 342,751 647,468 626,958 705,414 815,942 76,144 437,570 498,645 629,037 827,400 21,332 13,472 11,631 9,815 7,985

1,810,734 1,723,938 1,697,428 841,096 703,590 674,454 963,846 1,017,082 1,021,916 5,792 3,266 1,058

1,511,320 1,627,500 1,187,273 613,595 679,531 336,780 897,653 947,906 871,762 72 63 -21,269

Bonds/Foreign Debt Bonds/Debt

17.3% 1.8%

Source: Bureau of Treasury

1

39.8% 20.2%

43.8% 20.9%

46.8% 22.3%

50.1% 24.7%

53.2% 25.3%

59.0% 26.2%

60.2% 26.5%

59.4% 24.2%

58.2% 23.9%

73.4% 31.1%

Crunch time

Source: IMF

5

Such external constraints on our fiscal capacity to target the poor via social welfare and induce jobs-creating GDP growth via infrastructure compose the nexus of the financial crisis to poverty. Aside from tight credit markets making foreign borrowings expensive, privatization options have all but evaporated. In the meantime, the slowdown in the global real economy would also bite into tax revenue flow. [Many states in the USA have already reported a 6% inflation-adjusted fall in their 3Q revenues]. The 3% cut in nominal GDP growth will mean at least P18bn in revenue loss at P6bn per 1% nominal GDP. Global trade financing contraction will also bite into customs collections. Worse, such organic weakness in revenues would coincide in 2009 with the full impact of structural impairments. These are income tax relief (P32-36bn) and lowering of corporate income tax from 35% to 30% (P15-18bn). This totals to a P65bn risk to our revenue target. Why not domestic credit? Given strengthening of reserve currencies (dollar, yen and euro), domestic money supply must be tightened. Unsustainable deficits can easily trigger a spike in domestic interest rates that will only offset the positive impact of public spending if it deters consumer spending and private capital outlay. The government just ends up with more debt without achieving the desired downside protection. It would be more prudent to contain the target deficit, thus the consequent NG net borrowings, to 1.5% of GDP or P132bn in 2009 and P142bn in 2010 to hold interest rates stable. The recent policy shift from balanced budget to the 1.5% deficit to GDP will not allow incremental spending but will only enable us to keep a P1.4trn spending aggregate given the P65bn structural weakness built into the revenue program. Even if we succeed in quickly pushing up absorptive capacity, the window for countercyclical deficit spending has already radically narrowed by the global credit squeeze. In short, increased demand for social programs can only be funded by a realignment of priorities, not by additional borrowings.

Such fundamental weaknesses foreclose countercyclical stimulus or safety nets programs. We could not even match the financial moves of developed economies to protect their banking industry via full deposit guarantee or even just an increase in deposit insurance coverage as this would entail massive government cash infusionP40bn for PDIC. Another P40bn is needed to boost the financial flexibility of the BSP in executing monetary responses. Overall The risks can be summed up as (1) Financial: Weak spontaneous credit markets are a big hole in our financial dike in the midst of capital outflows, export weakness and even possibly slowdown in OFW, tourism and BPO flows (2) Non-financial or Real Economy: Organic and structural revenue weakness coinciding with restrictive credit markets will impair fiscal capacity to implement countercyclical economic stimulus or to expand social welfare programs in the midst of rising unemployment and stagnant incomes. Conclusion GLOBAL. The crucial policy imperative for G7 is to restore the liquidity pipelines to emerging economies, particularly in Asia, to prevent them from tipping over since they would be more difficult and expensive to pull out when they have fallen off the cliff with knock-on effects on other economies and potentially aggravate the systemic risks to the entire global economy that is already bound for cyclical weakness. Since governments of advanced economies are so preoccupied with their domestic mess to conduct bilateral negotiations while banks are just being recapped and are likely to be more risk-averse while it will take a lot of exertion to reboot spontaneous credit markets, the IMF emerges as a second best option. Yet, it is difficult to see IMF implementing a general bailout given its limited capital and its institutional procyclical reflexes. THE PHILIPPINES. The current public complacency is most disturbing as it would make the inevitable adjustments more painful with increasing signs of a more dysfunctionally inward-looking one-party administration in the US- bailing out automotive manufacturing beyond the “systemically significant institutions” like banks. (1) Financial. The most immediate and critical intervention is to secure our banking sector by increasing maximum deposit insurance from P250T to P1M as depositor confidence is the point of maximum leverage in this context of uncertainty and competitive moves of our neighbors in this regard. This must be accompanied by a P10bn cash injection into PDIC with P30bn callable. The long overdue capital infusion into the BSP must also be made sooner. Congress must move more quickly. The second move is for the Philippines to continue the diplomatic push to secure access to forex financing as PGMA initiative in the recent ASEM in Beijing. Other options include (1) G10 to immediately commit $500bn to IMF, compared to the $3.3trn bailouts they have printed for themselves. Modifying IMF reflexes is another thing; it would remain a challenge. (2) G10 could also infuse capital into WB and ADB, (3) Japan must exert its leadership in Asia by putting up another plan like the Obuchi Initiative (3) maximize current credit lines

with multilaterals and seek an automatic reflow of gross repayments, the Philippines being a net payer (loan repayments higher than loan availments) (4) maximize JBIC credit lines (5) redevelop other bilateral lending from G10. (2) Monetary. In the next six months, the country faces tough choices in managing its external balances in an environment that may well just be the most challenging [since the 1983 difficulties] unless the G10 could magically restore the normalcy in spontaneous credit markets or put in place other pipelines of liquidity to developing nations like the Philippines. The basic choice for the BSP is either a major peso depreciation or a painful monetary stabilization [a la Jobo bills] unless multilateral assistance comes in quickly and that could significantly reduce the pain of adjustment. A little of both would just result in more of both. But a conscious monetary strategy will certainly be less painful than a disorderly adjustment exacted and enforced by market forces. (2) Fiscal. Given that monetary environment and the fallout of a global slowdown on Philippine real economy and consequently P53bn reduction of its revenue program for 2009, the national government must realign its budgetary priorities if it is to provide safety nets to the poor as higher deficits could just worsen the monetary imbalances. (3) Macroeconomic. GDP growth must be scaled down to 2x demographic growth from the more aspirational 6-8%, control inflation to 5%, contain economic stimulus within deficit targets, focus on productivity.