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Philippine Economy: In sweet spot, but facing difficult global challenges and has a lot of catching up to do. Felipe M. Medalla Monetary Board Member Bangko Sentral ng Pilipinas September 25, 2012 • 1. Philippine Economy is in a sweet spot, but monetary policy in the advanced economies pose difficult challenges for Philippine economic policy makers. • 2. Weak advanced economies reduce our growth prospects in second half of 2012 and in 2013 • 3. Weak economy in US means another round of QE • 4. Rising sovereign bond yields for troubled economies in Euro zone (e.g., Spain and Italy) mean ECB will have its own version of QE (what Draghi called Outright Monetary Transactions). • 5. #3 and #4 mean more portfolio inflows (which means lower GS yield and upward pressure on the peso) • 6. If non-residents are buying Phil GS, where will Filipinos and Philippine Banks put their money? • 7. Will #6 result in bubbles and too much credit growth than is good for our macroeconomic and financial stability? Philippines is in a “mini” demographic transition. The fastest growing segment of our population is from age groups which earn and save more. Age Distribution of Household Population Population Age Group 1995 2010 0-14 26,141,749 30,717,524 15-19 7,186,725 9,676,359 20-24 6,401,280 8,370,398 25-34 10,509,534 14,134,090 35-64 15,668,613 25,193,409 65+ 2,441,551 4,006,198 Total 68,349,452 92,099,988 Source: www.census.gov.ph % Distribution 1995 38.2% 10.5% 9.4% 15.4% 22.9% 3.6% 100.0% 2010 2010/1995 33.4% 1.18 10.5% 1.35 9.1% 1.31 15.3% 1.34 27.4% 1.61 4.3% 1.64 100.0% 1.35 The demographic transition raised our savings rate.... and, together with OFW remittances, generated 10 consecutive years of current account surplus in our balance of payments (which raised our GIR, making our external balance virtually invulnerable to global shocks like the collapse of Lehman). In short, we don’t need foreign funds. Chart 3. CURRENT ACCOUNT (BPM5 Concept), annual, in US$ million and as % of GDP 10000 8 CURRENT ACCOUNT (left scale) Average As % of GDP (right scale) 8000 6 6000 4 4000 2 2000 0 0 1999 -2000 -4000 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 p/ -2 -4 Passage of EVAT and our external surpluses moved us out of the vicious cycle of public debt (high deficit and depreciating currency high credit spreads high interest expense of the government high deficit…) Real Per Capita Government Revenue, Taxes, Expenditures and Interest Expense 18000 16000 14000 12000 10000 Total Revenues Tax Revenues 8000 Expenditures exc. Interest 6000 Interest Expense 4000 2000 1996M12 1997M5 1997M10 1998M3 1998M8 1999M1 1999M6 1999M11 2000M4 2000M9 2001M2 2001M7 2001M12 2002M5 2002M10 2003M3 2003M8 2004M1 2004M6 2004M11 2005M4 2005M9 2006M2 2006M7 2006M12 2007M5 2007M10 2008M3 2008M8 2009M1 2009M6 2009M11 2010M4 2010M9 2011M2 0 6 Philippine Fiscal Deficit is very managable (especially if congress passes the sin tax and fiscal incentives rationalization laws) Market perceptions of improving Philippine sovereign credit risk are way ahead of credit rating agencies. 8 Both the slope and intercept (level) of the GS Yield curve fell significantly. Chart 4. Philippine Secondary Market Yields In percent 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 0 12 September 2012 31 August 2012 30 September 2011 31 December 2007 31 December 2002 1-mo 3-mo 6-mo 1-Yr 2-Yr 3-Yr 4-Yr 5-Yr 7-Yr 10-Yr 20-Yr 25-Yr Share of Interest Expense in Total Expenditures of the National Government (based on 12 mo running totals) 35% 30% 5% 0% 1996M12 1997M8 1998M4 1998M12 1999M8 2000M4 2000M12 2001M8 2002M4 2002M12 2003M8 2004M4 2004M12 2005M8 2006M4 2006M12 2007M8 2008M4 2008M12 2009M8 2010M4 2010M12 1996M12 1997M8 1998M4 1998M12 1999M8 2000M4 2000M12 2001M8 2002M4 2002M12 2003M8 2004M4 2004M12 2005M8 2006M4 2006M12 2007M8 2008M4 2008M12 2009M8 2010M4 2010M12 …significantly expanding the national government’s fiscal space. Real Per Capita NG Interest Expense (pesos per capita) 6000 5000 25% 4000 20% 3000 15% 10% 2000 1000 0 10 With the fall in interest rates and appreciation of the peso, our economy has outgrown our public debt. Chart 2. Total Public Sector Debt as % of GDP, 1998-2010 6000 100 90 5000 80 70 4000 60 2010: 58.5% 3000 50 40 2000 30 20 1000 10 0 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Economic growth in the first two quarters surprised most economists. Even if the BOP crisis years (1984, 1985, 1991, and 1998), average GDP growth between 1950 and 2010 was only 5%. Share of Industry in GDP fell from a peak of 42% in the early 1980s to 32%. Moreover, seasonally adjusted quarter on quarter GDP growth is quite low. 100 Chart 1. Real GDP Growth and Shares of AIS to GDP 12 90 10 80 8 6 70 4 60 2 50 0 40 -2 30 -4 -6 10 -8 0 -10 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20 Services Agriculture Industry Real GDP Growth (right scale) The sectors that declined (in terms of employment shares) are the sectors that have to compete with imports in the domestic market or with exports from other countries in foreign markets. Employment Shares by Major Industry Groups: January 1996 and 2012 Labor Force Surveys 60 50 40 Jan 1996 30 Jan 2012 20 10 0 Agriculture Manufacturing Rest of Industry Services Much of the increase in service sector employment is associated with low wages or non-wage income. Service Sector Share in Total Employment 30 25 20 15 Jan 1996 Jan 2012 10 5 0 Wholesale and Retail Trade and Repair of Motor Vehicles and Motorcycles Transportation, Storage and Communications Financing, Insurance, and Real Estate Rest of Service Sector Service Sector employment is in the non-tradeable sectors(does not compete with foreign producers) and has strong links with the informal sector and coping with poverty (e.g., daughters of farmers working as maids in the cities) and government payrolls (teachers, government employees, police and military personnel). Break down of Service Sector Share in Total Employment :Jan 2012 LFS Services Wholesale and retail trade; repair of motor vehicles and motorcycles Transportation and storage Accommodation and food service activities Information and communication Financial and insurance activities Real estate activities Professional, scientific and technical activities Administrative and support service activities Public administration and defense; compulsory social security Education Human health and social work activities Arts, entertainment and recreation Other service activities Activities of households as employers; undifferentiated goods and services 52.7 19.3 6.9 3.2 0.9 1.3 0.4 0.5 2.3 5 3.4 1.2 0.9 2.3 4.9 The fall in the share of manufacturing and the rise in the share of services in our country look more similar to what happened to the sectoral employment shares in rich advanced economies than in developing economies. The “maturation” of labor export has resulted in a signficant drop in the growth rate of OFW remittances. (Aside from BPO, what will take the place of the high growth rates of remittances?) 26 Figure 2. Gross Fixed Capital Formation as % of GDP: Selected Asian Economies Birth rates fell much less in the Philippines than in Indonesia and Thailand Fertility rates among well-off and better educated mothers is now close to replacement rate. Those of poor and less educated mothers are significantly higher than their desired fertility and are nearly twice replacement rates. ACTUAL VS WANTED FERTILITY (No. Of Children) By Wealth Quintile and Mother’s Education ACTUAL WEALTH QUINTILE Lowest Second Middle Fourth Highest MOTHER’S EDUCATION No education Elementary High school College or higher WANTED DIFFERENCE 5.9 4.6 3.5 2.8 2 3.8 3.1 2.6 2.2 1.7 2.1 1.5 0.9 0.6 0.3 5.3 5 3.5 2.7 4.1 3.3 2.5 2.2 1.2 1.7 1 0.5 Parents with large number of children invest less in the education and health of their children. High birth rates among the poor have resulted in a less educated labor force. 45.5% of the labor force have not finished high school. DISTRIBUTION OF EMPLOYED WORKERS BY EDUCATION AND AGE, JAN 2011 EDUCATION 15 - 24 25 - 34 35 - 44 AGE GROUP 45 - 54 55 - 64 65 AND OLDER All Ages Elem HIGH ALL Grad or Below SCHOOL College College EDUC Lower HS Grad Grad Undergrad Grad LEVELS 25.7% 45.8% 31.5% 12.8% 10.0% 100% 20.5% 33.0% 29.0% 16.5% 21.5% 100% 29.9% 42.3% 28.7% 14.2% 14.7% 100% 38.9% 50.6% 23.3% 11.9% 14.2% 100% 51.4% 61.7% 17.7% 8.7% 11.9% 100% 73.1% 32.1% 81.5% 45.5% 8.9% 26.5% 3.8% 13.2% 5.7% 14.9% 100% 100% Why according to Benanke, the academic, QE might work (even in the absence of fiscal stimulus). “He refers, of course, to the fact that the BOJ has for some time now pursued a policy of setting the call rate, its instrument rate, virtually at zero, its practical floor. Having pushed monetary ease to its seeming limit, what more could the BOJ do?.... Isn’t Japan stuck in what Keynes called a .“liquidity trap.”? ….Far from being powerless,the Bank of Japan could achieve a great deal if it were willing to abandon its excessive caution … The argument that current monetary policy in Japan is in fact quite accommodative rests largely on the observation that interest rates are at a very low level. I do hope that readers who have gotten this far will be sufficiently familiar with monetary history not to take seriously any such claim based on the level of the nominal interest rate. However, as I will argue in the remainder of the paper, liquidity trap or no, monetary policy retains considerable power to expand nominal aggregate demand. I will illustrate by discussing a mechanism that is highly relevant in Japan today, the so-called “balance-sheet channel of monetary policy.”.. Therefore money issuance must ultimately raise the price level, even if nominal interest rates are bounded at zero. …..I believe that a policy of aggressive depreciation of the yen would by itself probably suffice to get the Japanese economy moving again… Suppose the Bank of Japan prints yen and uses them to acquire foreign assets.. ECB is doing its own version of QE, to improve the balance sheet of troubled banks and countries. BSP purchases of forex have been largely sterilized using our SDAs.