Download price stabilization measures and its effects on

PRICE STABILIZATION MEASURES AND ITS EFFECTS ON
THE PHILIPPINE EXPORT SECTOR1
Cesar B. Quicoy, Amelia M. L. Bello and Tirso B. Paris, Jr.2
INTRODUCTION
Price stabilization, which refers to the control or dampening of the inflation rate is one of
the primary objectives of Philippine government policy. Price stability, as opposed to high
inflation rates or the rapid increase in the general price level of goods and services, has been
shown to be conducive to long run and sustainable growth of the economy. On the other hand, a
rapid rise and wide fluctuation in price levels is considered undesirable both on the part of
consumers and producers.
Policymakers in general have several ways to stabilize prices. One is through price
control measures such as setting ceiling prices. The other way is through non-price control
measures such as productivity improvement programs and increased investments in
infrastructure and other supporting services. The government may likewise use monetary
policies such as increasing its reserve requirement for banks to siphon off excess liquidity to
control inflation.
In the past, price controls were imposed to restrain the rapid rise in the prices of basic
commodities such as rice, corn, sugar, cement, fertilizer, etc. Price controls have been shown,
however, to result to distortions in production, resulting to inefficiencies and welfare losses. The
government ends up defending and supporting floor and ceiling prices using limited resources
and in effect sending wrong signals to industry. Price control policies have the direct effect on
transferring wealth to individual producers while transferring risk in the opposite direction. It
redistributes wealth and risk within the system, distorting the traditional market free signal
mechanism.
Rausser, et. al. (1982) documented the distortions arising from government instruments
on both domestic and industrial agricultural systems. For instance, the introduction of a ceiling
or floor price means that at this price, the social marginal costs of producing each level of output
will no longer be equal to the social marginal benefits. The payment of a subsidy to importers of
a commodity to cover the latter's losses incurred by importing means that government revenues
from some source is needed to establish a domestic price different from the world price. In
effect, treasury revenue is used to keep domestic prices lower than the world price being paid to
import the commodity. Consumers respond to the lower prices by increasing consumption, but
farmers react to the lower price in the reverse direction. Consumers receive benefits through the
1
Paper presented in the Symposium on Economic Policy Agenda for the Estrada Administration, June 1, 1999 at
INNOTECH, Commonwealth Avenue, Diliman, Quezon City.
2
Assistant Professors and Professor, respectively, College of Economics and Management, University of the
Philippines Los Baños, College Laguna.
1
budget subsidy needed to implement the lower domestic price but they gain at the expense of the
producers who must pay an implicit tax of the same amount per unit. A major effect of such a
policy is to thus alter income distribution and resource allocation patterns. Efficiency losses or
welfare losses arise due to distortions in the allocation of resources from their most efficient uses
in production or consumption. To compound the problem, subsidies are difficult to administer
for political and administrative reasons. The subsidies are channeled to individuals through a
government bureaucracy which creates its own inefficiencies and disincentives to expand output
(Timmer, 1986). In short, price support and input subsidy programs are expensive programs for
the government to pursue and thereby are not sustainable. Hence, this paper attempts to suggest
some non-price measures to control inflation and achieve price stability.
The export sector stands to greatly benefit from a regime of stable prices. One of the
factors affecting the competitiveness of Philippine exports has been increasing factor costs or
input costs. Unpredictability in prices of inputs has resulted in less flexibility on the part of
exporters who are unable to efficiently plan ahead. Further eroding the competitiveness of our
exports is the strong competition from cheap producers like China and Vietnam.
CONCEPT OF INFLATION AND RELATED ISSUES
Inflation refers to the economic condition of continuously rising general level of prices of
goods and services, resulting in a loss of the purchasing power of money. The inflation rate is
one of the common indicators derived from the Consumer Price Index (CPI) which is a measure
of the average retail price of a standard “basket” of goods and services consumed by a typical
Filipino family. The composition of such standard basket is determined by a Family Income and
Expenditure Survey (FIES) periodically conducted by the National Statistics Office (NSO). In
brief, the Philippine CPI basket is accounted for by food items (58.5 percent), housing and
repairs (13.3 percent), clothing (4.4 percent), services (10.9 percent), fuel, light and water (5.4
percent) and miscellaneous items (7.6 percent). Because food accounts for more than half of
the index, variations in agricultural output, either due to seasonal factors or low agricultural
productivity have made the inflation rate more volatile. Inefficiencies in the agricultural sector
have led to a system chain reaction in the economy. These inefficiencies have led to higher
inflation, demand for higher wages, and consequently, the institution of food policies.
Several studies have raised the question as to the suitability of the CPI as a measure of
inflation especially for monetary policy. Crawford, et. al. (1997), for example, considered two
other measures of aggregate prices: the implicit gross domestic product (GDP) deflator, and unit
labor costs. There are also issues as to how the underlying or “core” inflation should be
measured and the size of the bias in CPI inflation. The core inflation index excludes either food
or energy products or both in order to reduce volatility in inflation figures. If food is removed
from the commodity basket, more moderate declines or increases in the prices of goods and
services than what the official inflation data shows will be recorded.
2
Types of Inflation
There are essentially three types of inflation: demand pull, cost push, and structural
inflation. Demand pull inflation is caused by higher aggregate demand compared to available
supply or aggregate demand exceeding full employment output. Cost push inflation is
characterized by the rise in prices resulting from increases in the cost of production without
corresponding increases in output. Examples of this would be increases not matched by
increased productivity of labor, hikes in international oil prices, higher cost of capital, increases
in prices of raw materials, and hikes in rental rates. Structural inflation occurs when there are
deficiencies in certain conditions in the economy such as a backward agricultural sector that is
unable to respond to the people’s increased demand for food, inefficient distribution and storage
facilities leading to artificial shortages of goods, and production of goods controlled by some
people.
There are evidences to show that past Philippine inflationary trends have been influenced
by a combination of the three causes, and these are often times interrelated to one another. When
several types of inflation occur simultaneously, it may be necessary to adopt a set of measures to
address the underlying forces behind the price changes. There are trade-offs to reckon with such
as the observed tendency of prices and unemployment to move in opposite directions. Slowing
the rate of inflation may mean an increase in the level of unemployment, lower levels of output,
and a possible recession in the economy.
Cost and Benefits of Low Inflation and Price Stability
There have been studies on the gains from price stability. For example, Feldstein (1997)
has shown that inflation exacerbates the tax distortions that would exist even with price stability.
The annual deadweight loss of a two percent inflation rate is a large one percent of GDP. Since
the real gain from shifting to price stability grows in perpetuity at the rate of growth of GDP, its
present value is a substantial multiple of this annual gain. Discounting the annual gains at the
rate that investors require for risky equity investments implies a present value equal to more than
35 percent of the initial level of GDP. Since the estimated cost of shifting from two percent
inflation to price stability is about five percent of GDP, the gain substantially outweighs the cost
of transition (Feldstein, 1997).
Available evidence suggests that the benefits of price stability are many and large while
the costs of getting there are transitory and small by comparison. Moreover, progress towards
price stability is easier when wages and prices are flexible and when the monetary authority has
credibility (Selody, 1997).
Inflation and Growth
There is a large and growing body of empirical literature on the relationship between
inflation and long-run economic growth. Despite this effort, robust estimates of the effects of
inflation on growth remain elusive. While most studies showed a negative relationship, the
range of estimates was large, and many studies found that the relationship was not statistically
significant (Ambler and Cardia, 1997). Using a general equilibrium model, they showed that
3
that there was a structural relationship between inflation and growth –- higher inflation reduced
growth. They suggested, however, that future empirical studies should take more care to control
for the factors that influence both inflation and growth since these are jointly affected by a
number of other factors.
While Ambler and Cardia focused on the long-run relationship between inflation and
economic activity, Dupasquier and Ricketts (1997) examined the short-run relationship. This
short-run relationship runs from output to inflation, with higher levels of economic activity
tending to push inflation up when aggregate spending in the economy runs ahead of the level of
output that the economy can supply on a sustainable basis. This positive short-run relationship,
known as the Phillips curve, is central to the implementation of monetary policy, since monetary
policy influences inflation through the effects of interest rates and the exchange rate on aggregate
demand.
Role of the Central Bank
The country’s monetary authority, the Central Bank, or the Bangko Sentral ng Pilipinas
(BSP) has the prime responsibility to maintain price stability conducive to a balanced and
sustainable growth in the economy. The BSP monitors the movements in prices, analyzes their
causes, and undertakes necessary measures to ensure that the money supply is managed in a
manner that does not contribute to inflation.
The BSP is principally concerned with regulating money supply in a manner consistent
with the economy's legitimate monetary requirements to be able to execute transactions smoothly
and deal with unforeseen contingencies. Too much money in circulation is often one of the basic
causes of inflation but it is very important to mention that not all inflation should be addressed
by monetary policy. An obvious example is inflation triggered by weather-related food supply
shortages.
The BSP has a well-planned monetary program precisely geared to regulating money
supply consistent with the anticipated level of economic activity that is believed to be
sustainable. It has with it monetary instruments to influence broad money growth such as
interest rates, reserve requirement, and open market operations.
CONCEPTUAL FRAMEWORK
The trends in inflation observed in the Philippines can be best explained by the new
structuralist view of inflation. The temporary agricultural shortages arising from weather-related
disturbances which were made worse by hoarding and the delayed rice importation as well as the
lagged development of transportation and communications are critical elements of the new
structuralist view. Unlike the monetarist view which uses monetary expansion to explain
inflation, structuralists give attention to supply-side effects in explaining price movements.
The first group of structuralists is made up of cost-push advocates. This group sees
inflation as being caused partly by increases in the cost of production, particularly wages and the
4
prices of imported inputs. A larger group of structuralists comprising the second group, however,
views inflation arising from the unbalanced growth of different sectors and production
bottlenecks.
The first type of production bottleneck stems from a slow growth of the export sector,
usually primary exports, which leads to export earnings being inadequate to support the import
requirements of industries. Since export earnings fall short of the import needs, this leads to a
slow growth of aggregate supply which means a persistent excess demand condition exerting a
continuous upward pressure on prices. This phenomenon also contributes to the uneven
relationship between exports and prices; an increase in export earnings may have an inflationary
effect by increasing aggregate demand but a fall in export earnings will exert or have no effect at
all on prices due to the structuralist argument and because prices are sticky downwards.
A constant shortage of food is the second major bottleneck. A persistent shortage of food
due to the backwardness of the sector would provide an upward push on the general price level.
Meanwhile, the downward rigidity of prices in the non-food sector which may be due to the
monopolistic or oligopolistic structure of the sector or strong trade unions would also cause the
general level of prices to rise.
Other major bottlenecks may be traced to structural features of the economy such as
lagged development of transportation, communication and other infrastructure, graft, corruption
and other types of bureaucratic delays as well as insufficient capital formation. These bottlenecks
diminish the competitiveness of industries. Figure 1 shows the structuralist view of Philippine
inflation.
Several studies have dealt with the welfare effects of inflation as well as the benefits of
price stability. When the present value of the benefits of low inflation is compared with the
present value of the cost of achieving (and maintaining) low inflation, the conclusion arrived at is
that the benefits of reducing inflation, which stem from both the reduced cost of holding money
balances and the elimination of distortions in the tax system, outweigh the costs.
The immediate impact of inflation is a decline in the purchasing power or in the amount
of goods and services any given amount of money can buy. Thus, households with a fixed
income can only buy a smaller amount of goods and services. Unfortunately, these usually tend
to be low- income households while higher-income households have more flexibility to
neutralize inflation by investing in assets that hold their value against inflation.
With the declining value of money, people would be more inclined to spend than save,
anticipating that their money can buy even less in the future. Therefore, inflation has adverse
effects on savings and investment.
5
6
Figure 1. Structuralist View of Philippine Inflation
Causes of Inflation
Cost-Push
Advocates
Policy Measures to Control
Inflation
high wages
high power rates
high prices of
imported inputs
Inflation
Unbalanced
Structural Growth
and Production
Bottlenecks
slow growth of primary exports
constant shortage of food
other structural features such as
lagged development of
transportation/communication,
insufficient capital formation
6
development of the export sector
liberalize food trade and food
diversification
increase investment in infrastructure,
research and development
development of the financial sector
7
8
Inflation can also erode the profitability of producers and the external competitiveness of
domestic products if it leads to higher production costs such as wage increases, higher interest
rate and currency depreciation. Price stability is critical for producers and exporters alike
because high and volatile prices of inputs reduce the flexibility of producers to efficiently plan
ahead. Increases in wage rates which are unmatched by increases in labor productivity
effectively result in higher production costs for the firm. This is especially important for firms or
industries which are labor intensive like the fruit-processing industry. The industry employs
manual labor for sorting, cooking, bottling and packing its products. The export industries also
need stable prices for their inputs to be able to respond quickly to new trends in market demand.
Otherwise, when firms are unable to do so, competition from cheap producers like China and
Vietnam will capture the market.
Most export industries also suffer from weak backward linkages. The garments industry,
which used to be the banner export industry of the country, is forced to import more than half of
its input requirements leading to high materials costs and longer turnaround time. This is also
true for the electronics industry which sources a great portion of its materials from abroad. These
industries require stable prices to maintain their presence in the global market. These industries
also need to be able to compete in the higher end segment of their market; price stability will
help these industries to do so. A period of stable prices will give the export industries time to
focus their strategies in improving and maintaining their global competitiveness without having
to worry about how much production costs will be because prices are rising unpredictably.
Empirical Studies on the Causes of Price Instability in the Philippines
A review of the factors affecting price stability in the Philippines will enable policy
makers to implement appropriate policies to maintain price changes at a manageable level.
Lim (1996) showed that cost-push and demand-pull factors are important factors in the
determination of the price level. The price of imported goods has the highest elasticity, followed
by wages and money supply.
An earlier study of Bautista (1983) showed that a large part of inflation for the period
1965-1982 could be attributed to world price increases and the depreciation of the peso. He
pointed out also that the increase in oil prices put more upward pressure on inflation. However,
his study did not find money supply and wages to significantly affect inflation.
Another study of Lim (1985) indicated that the increase in inflation was caused by the
rise in interest rates which increased the cost of borrowing for working capital. This was
supported by his empirical results that indicated a positive relationship between interest rates and
inflation. Meanwhile, Bautista (1991) showed that the forecast error variance of inflation due to
changes in the exchange rate was higher than that of money supply growth. However, the
empirical result of his study did not show that money supply growth fuelled by fiscal deficits,
was unimportant. Important items in production cost consist of wages, salaries, power rates, and
energy prices. Structuralists who advocate a cost-push driven inflation have pointed out that
inflationary pressures are generated by increases in nominal wage rates in excess of labor
productivity. As prices of food commodity rise, putting pressure on wages to increase and
7
engendering further price increases in the other sectors of the economy, a vicious cycle will
occur. This upsurge in the cost of living will push wages to increase independently of
productivity movements.
Wage rates in Manila are pegged at $7/day while in Bangkok, labor rates are at
$5.75/day. These have greatly affected labor-intensive industries utilizing low-skilled labor like
the fruit-processing, textile, and local garments industries.
Power rates and energy prices tend to influence the prices of output that cause
inflationary pressures in the economy. The Philippines has the highest retail price of electricity
in the ASEAN region although its electrification level is comparable with neighbors of similar
level of development (NEDA, 1998). Electricity rates in the country in 1997 were at
$0.1128/kwh while in Singapore, electricity costs were just $0.0865/kwh (Payumo, 1998).
Bernardo (1999) asserted that privatization and increased competition particularly at the
generation end could reduce power costs from the current average cost of the National Power
Corporation of P2.60/kwh to P1.60/kwh, or as much as 38 percent.
TRENDS IN INFLATION IN THE PHILIPPINES
The annual inflation rate in the Philippines has almost always been positive over the past
four decades (Table 1). Not only has CPI grown monotonically but its growth has been rather
rapid, compared to many developed and developing countries. In certain episodes of the postwar
economic history, inflation was double digit. These are much lower, however, than the
hyperinflation type suffered by countries like Argentina, Mexico, Russia, and recently Indonesia.
Since 1992, the average annual inflation rate has been kept at a single digit. A rate of 8.9
percent was posted in 1992, a marked deceleration from the 18.7 percent in the previous year. In
1993, inflation decelerated further to 7.6 percent. Inflation was higher at 9.0 percent in1994, but
still within the 9.5 percent target inflation in the economic and financial program supported by
the International Monetary Fund (IMF).
8
Table 1.
Average rates of inflation, selected countries, 1960-1996.
Country
Argentina
Australia
Bangladesh
Dominican Republic
India
Indonesia
Japan
Malaysia
Myanmar
Pakistan
Peru
Philippines
Singapore
Thailand
United States
1960-69
22.42
2.31
4.49
1.84
6.50
232.60
5.55
0.83
4.13
3.30
16.67
4.62
1.18
2.56
2.42
1970-79
127.93
9.83
19.60
9.20
7.54
16.92
9.09
5.50
10.86
11.76
26.84
14.64
5.91
8.00
7.10
1980-89
570.50
8.41
11.26
20.87
9.12
9.63
2.53
3.65
10.09
7.27
481.16
15.05
2.79
5.82
5.55
1990-90
361.27
3.21
4.52
19.04
10.06
8.62
1.44
3.97
24.17
10.77
1151.39
10.70
2.52
5.12
3.42
1960-96
269.86
6.27
10.57
12.52
8.21
67.20
4.90
3.52
11.55
8.21
369.16
11.48
3.20
5.47
4.78
Source of Basic Data: World Development Indicators, The World Bank, 1998
Based on CPI (1987=100)
Several cost-push factors tended to raise inflationary pressures (Tables 2 and 3). These
included temporary agricultural shortages spawned by the series of typhoons in December 1993,
phased increases in minimum wages in December 1993 and April 1994, some speculations about
the temporary fuel price increases early in the year and the impending implementation of the
expanded value-added tax (EVAT). A depreciating peso and the uptrend in interest rates and in
money supply growth also partly pushed prices upward during the period.
Prices during the first half of 1995 were generally stable despite some unanticipated
external shocks and the rising domestic liquidity in the early part of the year. However, this trend
was reversed in the last four months of the year as the rice shortage pushed inflation to doubledigit levels. Supply-side factors such as the dry spell which significantly affected rice and corn
production, the resulting rice shortage which was aggravated by hoarding and delayed rice
importation, and the foot-and-mouth disease in hogs contributed to the increase in prices. For
1995, inflation averaged 8.0 percent compared with the year-ago level of 9.0 percent and the
whole year target of 6.5-7.5 percent. For the first quarter of 1996, inflation remained doubledigit at an average of 11.6 percent. The lingering effect of the rice shortage, the implementation
of the EVAT, the increase in the prices of oil products, and their combined influence on higher
price expectations contributed significantly to this relatively high price regime.
The recent financial crises resulted in a higher inflation rate in 1997 and 1998, but were
contained within the single digit target level. In 1998, inflation rose to 9.7 percent (1994=100)
due mainly to weather-related disturbances and lagged effects of the sharply depreciated peso
9
and high interest rates. However, the inflation rate was below the government’s target of 9.259.75 percent.
In the Philippine context at least, inflation is still regarded as a threat to macroeconomic
stability. After being maintained at a single digit level for the past four years, 1995–1998,
inflation reached double digit in the first quarter of 1999. The Philippines remains to be one of
the high inflation countries in Asia, although the average inflation rate of 8.2 percent from 1995
to 1998 was better compared to other Asian countries affected by the financial crisis. In
comparison to other Asian countries, price movements in the Philippines used to accelerate
faster. In 1992, the inflation rates of Malaysia, Taiwan, Thailand, and Singapore were recorded
at 4.7 percent, 4.5 percent, 4.2 percent and 2.3 percent, respectively, as compared to the
Philippines' 8.9 percent. Nevertheless, the inflation differential has narrowed down as the
country's inflation has moved more closely to those of said Asian countries.
Nominal interest rates for both borrowing and lending instruments of banks slightly
increased from 1992 to 1998. However, the growth in domestic interest rate is decreasing which
could be the result of the efforts of the government to bring down the bank’s cost of borrowing.
In addition, the downward trend of the nominal interest rate could have also been influenced by
the BSP’s policy of reducing the reserve requirements of banks that resulted in the reduction of
the intermediation cost. Furthermore, the moral suasion adopted by the BSP over banks to
operate in a manner that will contribute to the attainment of the monetary goal of the government
but consistent with the profit maximization of the banks also helped in the reduction of the
interest rate.
Table 2.
Consumer Price Index (CPI), Philippines, 1995-1998
ITEMS
1995
1996
1997
1998
Food and Beverages
Clothing
Housing and Repair
Fuel, Light and Water
Services
Miscellaneous
109.0
106.2
111.1
103.1
106.4
102.8
120.4
112.0
122.9
109.4
115.7
102.7
124.5
119.3
135.7
119.4
129.6
106.4
135.8
128.6
151.4
126.4
148.1
115.2
All
108.0
117.8
124.8
136.9
Source: Selected Philippine Economic Indicator, BSP, April 1999.
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Table 3.
Contribution to inflation by commodity, Philippines, 1995-1998
ITEMS
1995
1996
1997
1998
Food and Beverages
Clothing
Housing and Repair
Fuel, Light and Water
Services
Miscellaneous
5.00
0.20
1.60
0.20
0.80
0.20
5.80
0.20
1.60
0.30
1.10
0.00
1.90
0.20
1.50
0.50
1.50
0.30
4.85
0.29
1.70
0.34
1.80
0.70
All
8.00
9.10
5.90
9.70
Source: Selected Philippine Economic Indicator, BSP, April 1999.
PERFORMANCE OF THE EXPORT SECTOR
Exports continued to grow from U.S. $ 20,543 million in 1996 to U.S. $ 29,496 million in
1998 (Table 4). However the rate of growth of export decreased from 22.81 percent in 1996-97
to 16.92 percent in 1997-98. Imports on the other hand, experienced a downward trend from
U.S. $ 36,355 million in 1996 to U.S. $ 29,524 million in 1998. With the positive growth of
exports of 16.92 percent and a negative growth of 18.79 percent in imports and because of the
peso devaluation and economic slowdown, the trade balance deficit declined significantly to
about U.S. $ 28 million in 1998 (compared to U.S. $ 11.13 billion trade deficit in 1997).
Tables 4 and 5 show the performance of the export sector. In 1998, the total value of
Philippine merchandise export amounted to US $ 29.496 million or about 43 percent of GNP at
current prices. Total exports have shown an impressive growth in the last five years. In 1998,
total exports grew by about 17 percent, although it declined slightly compared to the 1996-97
growth rate of about 23 percent. However, deeper analysis shows that this export success is
largely illusory (Table 5).
The structure of the export sector is lopsided. It is dominated by only two manufacturing
industries: the electronics or semi-conductor and the garment industries. In 1998, the electronics
and garment industries contributed about 58 percent and 8 percent of the total export receipts,
respectively. Thus, the two industries contributed more that 65 percent of the total export value.
This structure has been existing since the 1980’s. It is interesting to note, however, that the two
industries have very limited contribution to the domestic economy because substantial amounts
of their input requirements are imported. Take the case of the electronic industry; the country
does not have the technology to supply its input requirements. It sources from 75 to 90 percent of
its materials from abroad. The garment industry, on the other hand, has to import raw fabric to be
competitive in the world market because of the inefficiency of the local textile industry. Thus,
11
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Table 4.
Philippine exports by major commodity, 1990-1998 (In million U.S. $)
Year
Commodity Group
1990
1991
1992
1993
1994
1995
1996
1997
1998
Coconut Products
496
Sugar and Sugar Products
133
Fruits and Vegetables
326
Other Agri-Based Products
431
Forest Products
94
Mineral Products
442
Petroleum Products
155
Manufacturers
5995
439
136
393
504
73
388
175
6633
633
110
371
432
57
416
150
7525
494
139
439
476
45
422
136
9031
607
77
429
530
26
510
132
10917
974
74
458
575
38
552
171
14224
730
139
486
506
42
772
273
17106
835
99
459
506
45
764
157
21488
831
100
446
465
24
591
129
25866
1964
1776
2293
1861
2753
2140
3551
2272
4984
2375
7413
2570
9990
2423
13052
2349
17156
2356
Special Transactions
Re-exports
19
95
17
82
37
98
38
165
74
181
108
273
157
332
263
512
311
733
TOTAL EXPORTS
8186
8840
9829
11375
13483
17447
20543
25228
29496
Elec. & Elec. Eqpt./
Parts & Telecom
Garments
Source: Foreign Trade Division, NSO
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Table 5. Philippine exports by major commodity, 1990-1998 (In percent change).
Commodity Group
Coconut Products
Sugar and Sugar Products
Fruit and Vegetables
Other Agri-Based Products
Forest Products
Mineral Products
Petroleum Products
Manufactures
Elec. & Elec. Eqpt/Parts & Telecom
Garments
Special Transactions
Re-exports
TOTAL EXPORTS
1991
(11.49)
2.26
20.55
16.94
(22.34)
(12.22)
12.90
10.64
16.75
4.79
(10.53)
(13.68)
7.99
1992
1993
Year
1994
1995
44.19 (21.96)
22.87
(19.12)
17.27 (40.31)
(5.60)
18.33
(2.28)
(14.29)
10.19
11.34
(21.92) (21.05) (42.22)
7.22
1.44
20.85
(14.29)
(9.33)
(2.94)
13.45
20.01
20.88
20.06
28.99
40.35
14.99
6.17
4.53
117.65
2.70
94.74
19.51
68.37
9.70
11.19
15.73
13
18.53
1996
1997
1998
60.46 (25.05)
14.38
(0.48)
(3.90)
87.84 (28.78)
1.01
6.76
6.11
(5.56)
(2.83)
8.49 (12.00)
0.00
(8.10)
46.15
10.53
7.14 (46.67)
8.24
39.86
(1.04) (22.64)
29.55
59.65
(5.86) (49.81)
30.29
20.26
25.62
20.37
48.74
34.76
30.65
31.44
8.21
(5.72)
(3.05)
0.30
45.95
45.37
67.52
18.25
50.83
21.61
54.22
43.16
29.40
17.75
22.81
16.92
14
13
while the two industries contributed substantially to the total export receipts, they are also the
major users of such receipts through imports of their raw material requirements. In net terms,
their contribution to the total export value has been minimal.
Although total exports grew by about 17 percent in 1997-98, the traditional export
products (e.g., coconut, sugar, fruits and vegetable, etc.), have generally been in a dismal stage
with only sugar and sugar products showing a positive growth rate of 1.01 percent in 1997-98
(Table 5).
In the last two years, machinery and transport equipment replaced the garment industry as
the second largest contributor to the total export value. In 1998, it contributed 11 percent of the
total export receipts. The electronics industry, however, continues to contribute substantially to
the growth of the export sector. In fact, it contributed about 58 percent of the total export value
in 1998.
Although the Philippines showed the highest export growth in 1998 compared to other
Asian countries, it is one of the few (including India and Sri-Lanka) countries still experiencing a
negative balance of trade. This continuous negative balance of trade despite a significant increase
in export is due to the import dependence of the export sector for their inputs.
POLICY REFORMS TO STABILIZE PRICES AND SUSTAIN
ECONOMIC GROWTH
Under a free market system, prices of basic commodities are determined by demand and
supply conditions. Domestic supply, is, in turn, determined by domestic production and
foreign trade. Measures that promote, therefore, domestic production and improve access to
foreign supplies of commodities can help stabilize prices. This implies that a more liberalized
trade regime is beneficial towards price stability.
The government, through its various agencies, is pursuing production-related programs
and has instituted policies to enhance productivity, efficiency, and competitiveness. These
include production programs, training, provision of basic infrastructure like irrigation and farmto- market roads, shipping ports, storage and post harvest facilities, credit, etc. There are also
long- term programs such as increased agricultural research expenditures. For agriculture, the
productivity and efficiency enhancing measures are contained in the Agricultural and Fisheries
Modernization Act (AFMA).
Measures to improve competitiveness such as improved productivity and efficiency of
the country's products in the world market are also beneficial in terms of price stability. The
recent commitment of the country to the World Trade Organization (WTO) has, therefore
improved the country's chances of achieving price stability through trade liberalization
particularly of basic commodities. When the country is in short supply of a certain commodity, a
more liberalized trade regime would prevent a large hike in domestic prices.
14
It appears then that while price stabilization is the prime responsibility of the BSP
through the prudent use of monetary policies, fiscal policy also plays an important role, not only
in terms of appropriate tax and expenditure policies but also specifically in fostering a more
conducive economic environment within which producers in agriculture and non-agriculture are
operating. The possible measures which can help combat inflation and promote price stability
within the country are as follows:
Production-related Measures
For the years 1993-1998, the agriculture sector exhibited relatively low levels and growth
of productivity. Average annual growth rates in yield for palay and corn were only 0.6 percent
and 2.8 percent respectively. Abaca, coconut, and sugarcane had negative rates; 5.6 percent, 0.2
percent and 5.3 percent, respectively, pulling the agricultural sub-sector's productivity to a
negative rate of 7.2 percent. (Table 6). The limited and inefficient provision of support services
was a significant factor to low level and growth of agricultural productivity in the country.
Irrigated land only slightly increased. Inadequate postharvest facilities were manifested in
significant postharvest losses and the poor infrastructure impeded the flow of agricultural
commodities (Medium-Term Development Plan 1999 - 2004, NEDA).
Table 6.
Average growth in yield (MT/ha.) for agricultural crops, Philippines, 1993-1997
Average Annual Growth
1993-1997
Sub-sector
AGRICULTURAL CROPS
(7.2)
MAJOR CROPS
Palay
Corn
Coconut
Sugarcane
Banana
Pineapple
Coffee
Mango
Tobacco
Abaca
Other Crops
(12.2)
0.6
2.8
(0.2)
(5.3)
1.9
17.6
(0.8)
6.0
0.4
(5.6)
7.0
Source: Report on the Performance of Agriculture, Bureau of Agricultural Statistics.
15
Some economists predict that the country will bounce back from the economic crisis by
the end of 1999. However, the rate of economic recovery will depend on the government policy
adjustments in order to improve the balance of payments, lower inflation rate, and sustain
economic growth. Favorable weather condition, which is an exogenous factor and the
improvement in peace and order condition are also considered important to promote stability in
output. While the immediate concern of the government is to address the economic vulnerability
of the country brought about by the financial crisis, long-term solutions to lower inflation rate
and sustain economic growth should be given top priority. Some of the production-related
measures are as follows:
1.
Increase investments in infrastructure and research and development. Studies in the
role of infrastructure in Mexican Economic Reform (Feltenstein and Ha, 1995) have
shown that improvements in infrastructure (e.g., electricity and communication) help
increase output and stabilize prices. Improvement in road and infrastructure facilities is
a pre-requisite to the social and economic development of the country. Improvements in
infrastructure would enable producers to reduce the unacceptable high cost of marketing
and in some cases, even open up access to market for remote producers/farmers.
Furthermore, it would minimize the delays in the delivery of goods and services and
boost production and thereby increase the income of small producers without necessarily
increasing the prices of their products.
To help facilitate the improvement of infrastructure, the Department of Trade and
Industry (DTI), the Department of Agriculture (DA), and Local Government Units
(LGUs) can assist the Department of Public Works and Highways (DPWH) in setting
priorities for infrastructure development in areas where lack of transport and other
production and post-production facilities are major constraints in increasing food supply.
2.
Increase irrigation investment. Investment in irrigation includes new irrigation
development and rehabilitation of existing irrigation systems.
New irrigation
development will result in the conversion of rainfed areas to irrigated lands and marginal
to productive lands. With the increase in area planted and cropping intensity due to
availability of water, agricultural production is expected to increase. The impact of the
drought brought about by the “El Niño phenomenon” could have been minimized if a
suitable irrigation system had been developed. More lands devoted to agricultural
production will increase food supply and stabilize prices.
3.
Provide proper incentives to the financial sector to increase their credit exposure in
the agricultural sector. The anticipated favorable effect of the devaluation of the peso
on exports was not felt because of the tightening of credit due to higher interest rate. With
high cost of credit, small exporters could not expand their capacity and could not afford
to increase their imported inputs. The availability of credit to small producers is essential
for sustained economic development through increased productivity. The availability of
low cost credit to small producers will reduce the cost of production thus easing the
pressure to increase the prices of their commodities.
16
The expected increase in productivity will depend on the following conditions: (1)
the level of credit availed by the producers is sufficient to purchase the optimal level of
inputs; (2) the loan is used for the intended purpose; and (3) the added return in the use
of credit is sufficient to pay the added cost of credit
4.
Increase the role of informal lenders in the provision of credit. The government
should also adopt measures to encourage informal lenders to continue offering loans but
at reasonable rates to small producers/farmers. This can be done also by supporting the
informal credit lenders by providing proper incentives. In addition, the government
should help establish cooperatives and associations among small producers and build up
funds through savings and government bank rediscounting. With more credit available to
small and medium producers, supply of commodities will be increased which will result
to stable prices.
5.
Diversify food production. Since the country is always a host to strong typhoons
which destroy agricultural crops, it is important to diversify production of agricultural
crops other than the traditional crops that are vulnerable to weather-related disturbances,
such as root crops. It is also important to develop such other areas that are less affected
by typhoons and other weather disturbances, such as Mindanao. However, this would
require investments in infrastructure investment as well as resolving the peace and order
problem. This program will help increase the supply of food commodities and stabilize
prices.
6.
Develop the post-harvest sector. The government should support the development of
the post-harvest sector in order to reduce losses and improve the quality of agricultural
commodities. With improved post-harvest facilities, producers can avail of the incentives
of adopting post-production practices and technology, thus increasing their income
without increasing the prices of goods and services. In addition, reducing losses through
improved post-harvest facilities and technologies would clearly increase food availability
and stabilize prices in the country. The government should require the active
participation of different agencies involved in post-harvest development. A lead agency
should be assigned to coordinate the efforts of different agencies/institutions to facilitate
the development of the post-harvest sector.
7.
Liberalize trade in food. The government should continue to liberalize the trade in food
commodities. If we cannot source low-cost supplies of food domestically, then we must
be prepared to procure low-cost food from the world market. However, the government
in liberalizing the importation of food items should allow the private sector to participate
actively in the importation of agricultural commodities (e.g., grains and sugar) during
times of shortage and export during the surplus period. Opening the international market
to the private sector would create incentives for quality improvement and employment
opportunities in the country. In addition, the government should help producers of food
to be self-reliant. With sufficient supply of commodities, prices will be stabilized.
17
8.
Provide a more effective and efficient market information system (MIS). The MIS
must be strengthened to improve marketing efficiency through effective dissemination of
relevant information pertaining to production and marketing. It is envisioned that
strengthening the MIS will create a more competitive environment among interested
parties – producers, traders and consumers- thus improving their economic welfare.
Effective and efficient market information will decrease the cost of marketing, thus
easing the pressure to increase prices. Furthermore, such information system would be
very useful for facilitating the intra- and inter-regional trading of commodities in the
country which would help stabilize prices.
An example of this is the Electronic System of Trading Agricultural Products program of
the National Food Authority (NFA) to help facilitate the transaction of corn buyers and
producers by reducing transaction cost. Corn buyers normally located in Metro Manila
and Cebu can transact business with local corn producers located in Mindanao and
Northern Luzon without spending hundreds of pesos. This program can also be adopted
to other agricultural commodities and sectors of the economy.
Fiscal and Monetary Reforms
Macroeconomic management has improved a lot in the Philippines since the Marcos
years. The BSP was made an independent institution. Second, the government had privatized a
lot of money-losing state enterprises, which had drained government finances. However, these
policies are not enough to cushion the impact of economic crisis. More reforms in monetary,
fiscal, exchange rate, and trade policies should be adopted.
1.
Institute further reforms in financial markets. Measures to boost domestic savings
should be adopted by the government. In addition, measures to attract foreign investors
should also be implemented. Attracting foreign investors can be achieved by improving
the stock market operations through transparency and efficiency in its operations. Small
investors should likewise be protected to ensure the continuity of their participation in the
capital market.
The government should try to tap other financial institutions (e.g., insurance and
pension companies) to boost domestic savings and help cater to the long-term investment
requirement of the country. A neutral and unbiased tax system will also encourage other
financial institutions to augment domestic savings. The policy of government of
encouraging mergers among financial institutions is a big help in attaining stability in the
financial system.
2.
Develop the export sector. The export sector plays an important role in attaining
positive growth in the current account. The performance of the export sector during the
financial crisis indicates that the development of the export industry as a source of growth
in the current account is more sustainable in the long-run than relying on the remittances
of overseas workers.
18
With the devaluation of the peso, holding other factors constant, this should make
Philippine exports competitive in the world market. However, during the financial crisis,
exporters were not able to take advantage of the opportunities due to the lack of capital
and other markets that were not affected by the financial crisis. The government should
help develop other markets for Philippine exports to minimize the impact of economic
disturbances. In addition, the government should assist the export sector in improving
the skill and capabilities of their workers to be efficient in the production of their output.
Likewise, the government should help promote the country's export products in other
countries that are not importing Philippine products.
3.
Broaden the tax base and improve efficiency in tax collection. The budget deficit
experienced by the country for so many years was partly attributed to low tax collection.
Government budget deficits if not corrected, sooner or later, have to be financed through
money creation, which is inflationary. With the broadening of the tax base and efficient
tax collection, the fiscal deficit could be minimized thus easing the pressure on interest
and exchange rates which will help stabilize prices.
4.
Institute BSP Monetary Measures. The BSP has at its disposal a number of monetary
policy measures that can eventually influence the movement of price levels. These
include regulation of money supply, prime interest rates, and reserve requirement rates.
While these are usually used to influence credit conditions, the investment climate, and
eventually output and employment, these variables can also be used to influence inflation
rates. The BSP has kept its hands off the dealing floor, allowing the peso to fluctuate and
seek its market rate. While a strong peso can be used to dampen inflationary pressures,
this policy is only correct to an extent in the short term. Furthermore, the cause of
inflation should be determined. The current inflation is not a monetary phenomenon but
a cost-push one combined with and “El Niño” supply shock or a structural defect. In
addition, the BSP should be more active in monitoring and supervising the financial
system to prevent defaults in the banking system (e.g., Orient Bank, Monte de Piedad,
etc.).
Issues on the Adoption of Inflation Targeting In Developing Countries
Inflation targeting is a framework that be used to conduct monetary policy in order to
maintain a low and stable rate of inflation. Its adoption would indicate the strongest possible
commitment by the monetary authorities to deal with the danger of inflation.
In an internet article entitled "The Eternal Triangle", Krugman (1999) argued that
countries face a dilemna in choosing its monetary regime. The three main goals of adjustment,
confidence and liquidity conflict with one another; choosing one implies dropping the other
objective. Following Krugman's definition of the three objectives, it looks like the Philippine
government is trying to strike a balance between the above-mentioned goals. It is allowing the
peso to float, while keeping interest rates low and inflation at manageable rates. In effect, the
administration is putting a premium on adjustment and liquidity, but at the same time
maintaining a relatively stable exchange rate by allowing the currency to float within a band.
19
The country has recently presented to the International Monetary Fund a new economic
program with higher growth rates and lower inflation. The Estrada administration is expecting
inflation to go down to 7- 8 percent this year. Next year, inflation is projected to go down to 6.5
percent. The rise in consumer prices would be slower this year and next year, with sufficient
food supply, a stable peso and a modest current account surplus. The government’s thrust of
easing interest rate has likewise set the phase for a more positive business environment.
Unlike other countries, such as Canada and New Zealand, the Philippines, has not
adopted an explicit inflation target whereby monetary and fiscal policies are adjusted in response
to an external shock in order to maintain a specific inflation rate. It appears, however, that the
target rate of inflation is currently somewhere in the neighborhood of 9 percent.
With an inflation target, the response of the BSP to a shock that pushes inflation above its
target would be to take action to return the inflation rate to its target. In this scenario, the price
level would rise as a result of the initial shock, and then the rate of increase in the price level
would be reduced until it would again equal the target rate of inflation. Thus, the initial increase
in the price level would not be reversed, and, there would be a permanent rise in the price level.
However, there are several prerequisites that have to be met in recommending the
adoption of core-inflation targeting. For inflation targeting to work, the BSP has to have
operational autonomy for monetary policy, a mechanism whereby the BSP is held accountable
for maintaining inflation within the target range, and a strategy for the transparent
communication of monetary policy objectives and actions to both financial markets and the
general public. By raising the profile of inflation, it will focus the attention of monetary policy
makers on the difficult decisions to be made. For political establishment, the explicit character
and transparency of the monetary policy arrangement will be helpful in focusing the debate on
the longer-term objectives of monetary policy. For the financial markets and the public at large,
the new framework is a key element in establishing expectations of low inflation. A clear target,
together with the transparency and frequency of the central bank’s public reports on monetary
policy will allow financial markets to better anticipate the emerging stance of monetary policy
and thus, reduce surprises.
These same prerequisites are mentioned in an internet article on inflation targeting
written by Masson, et. al. (1998). These include the following: (1) the central monetary
authority must have degree of independence and not show any symptom of financial dominance;
and (2) authorities should refrain from targeting nominal variables, such as the nominal
exchange rate since a country which chooses a fixed exchange rate effectively subordinates its
monetary policy to the exchange rate objective. In addition to the above prerequisites, a
monetary policy framework with essential features needs to be in place. Among the seven
countries that have so far practiced inflation targeting, a number of features are similar. All the
seven countries introduced inflation targeting when the inflation rate was already low. In
addition, inflation targeting is associated with a high degree of exchange rate flexibility and all
inflation targets were forward-looking.
20
Before advocating the adoption of core-inflation targeting in the country, the following
questions should, therefore, be posed: Does the Philippines meet the above criteria? Is the BSP
capable of conducting an independent monetary policy? Will inflation rates continue to remain at
a single digit level? In relation to the degree of Central Bank independence in the developing
countries, Masson, et. al. found out that fiscal dominance and poor financial infrastructure do
not bode well for an independent monetary policy in developing countries. Apart from these
findings, Masson, et. al. also raised the following additional issues against the adoption of coreinflation targeting by developing countries:
"1.
In most developing countries, there is no consensus about the optimum inflation rate,
which is one of the bases for setting the medium-term inflation target. Consequently,
any choice of such a target for developing countries might be seen as arbitrary;
2.
There is also no agreement on the speed with which the medium-term inflation target
would be attained in these economies. Some observers have argued that once a
developing country has brought down inflation to within the low-to-moderate range,
it should adopt a cautious approach to disinflation;
3.
The choice of a price index on which to base the inflation target is also likely to be
more problematic in developing countries than in industrial economies, since the
former tend to be subject to more numerous and variable supply shocks that affect the
price index and inflation; and
4.
In many developing countries, administered or controlled prices are an important
component of aggregate price indices and thus, of the short run behavior of inflation.
In such cases, a proper inflation forecast would need to take account of the timing and
extent of changes in those prices. This would require a higher degree of coordination
between monetary and fiscal authorities than in situations like those in industrial
countries where most markets are market determined."
Based on the foregoing discussions, it is apparent that the preconditions for adopting
core-inflation targeting are not yet present in most developing countries like the Philippines.
The issue on the degree of independence of the central monetary authority and the lack of
agreement on the optimum inflation rate, the choice of a price index, and the speed with which
the inflation target should be attained complicate the approach of inflation targeting in the
country.
CONCLUDING REMARKS
The price stabilization measures enumerated above which take the form of productionrelated as well as fiscal and monetary policies will enable the Philippine export sector to weather
future crises and improve their global competitiveness. Solving the structural bottlenecks in
production with reforms in the credit market and infrastructure will reduce price movements.
Furthermore, reducing the costs of doing business in the country by fostering a climate of stable
prices will improve the marketability and attractiveness of Philippine-made products. While this
is not the panacea for the multitude of problems that confront the export sector, these measures
will significantly promote the growth of the industry.
21
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23