Last Friday, the Bangko Sentral ng Pilipinas (BSP) decided to reduce its projection of this year’s balance of payments (BoP) shortfall from $1.6 billion to $1.2 billion. Relative to our gross domestic product (GDP), the adjustment translates to 0.3% from 0.4%. For next year, the deficit is expected to persist but at a lower level of $500 million, or 0.1% of GDP.
Such an upgrade of the external payments outlook reflects what is perceived to be continued recovery of external trade in goods and possible increase in travel receipts and business process outsourcing (BPO) revenues. Much of the assumption is anchored on lower prices of major commodities including fuel.
But the bigger picture should not be lost on us.
The global economy faces weaker prospects. While it should be some comfort for us that our current account deficit forecast is lower at $15.1 billion from the original forecast of $17.1 billion, that deficit forecast indicates that we continue to depend on foreign savings. We lack the productive capacity to sustain the pace of economic growth unless we import more, and there’s nothing patently wrong with that, but that should challenge our capacity to export more. Otherwise, we would be in constant need of a huge volume of either foreign investment or foreign borrowing to pay our way to economic growth.
This is what happened in the first five months of 2023.
We all rejoiced that the BoP yielded a surplus of $2.87 billion, reversing the shortfall of $1.53 billion in the same period in 2022. While the current account was somewhat mitigated by the net inflows from overseas Filipino workers (OFWs) remittances, it remained in deficit. The surplus in the overall BoP was possible only because of the net foreign borrowings by the National Government (NG) and foreign direct investments (FDI).
All up, we see the continuing challenge of fortifying our infrastructure, both soft and hard, more enlightened policy on external trade, stronger protection of our workers abroad, and a more attractive policy environment to our trade in services including BPOs. Agriculture and industry, particularly manufacturing, require a more sophisticated level of technological know-how to achieve higher efficiency and productivity in order to be more globally competitive. The shift to financial technology is urgent, and the banks and other financial institutions should continue their initiatives.
In another broadsheet, we clarified that the Philippines’ level of external debt continues to rise but as long as this exposure is used to promote economic growth, our ability to repay our debt will be sustained. The numbers would show that in the last 20 years, our ability to repay has expanded many times over. And our ability to turn around and fund economic growth is illustrated by the sustained economic growth from 1999 until 2019 before the pandemic.
At the same time, we cautioned against any propensity to revive the old and failed strategy of debt-driven economic growth. Coupled with bad governance and excessive corruption, that is a sure recipe for another disaster.
But that seems to be the emerging trend. Our overall BoP was also driven by inflows from heavier borrowings by NG. Those global bonds issued in the US, Europe, and some Asian capitals plus loans from both multilaterals and bilateral creditors are inflows in the BoP that could overshadow the current account deficit and effectively mask the reality of our dependence on foreign savings.
But over time, we could have a Catch-22 situation here due to the need to service these previous foreign borrowings. We can only expect more FX outflows in the financial account. What is interesting here is that most of those foreign borrowings are normally deposited with the BSP, boosting the level of GIR, only to be withdrawn when some previous debts mature and need to be paid back. We borrow to fund economic growth, but to the extent that our public revenues are not enough to service our debts, we would have to draw from these borrowings.
At the risk of being repetitive, the operationalization of the Maharlika concept could abet this kind of a situation because funds from the budget would be diverted to it, and away from the normal budget expenditure like education, health, and public roads. To match the amount of the diversion, the NG will have to add that to its usual borrowing schedule. If done excessively and frequently, that Catch-22 situation is not impossible.
What adds complexity to the equation is the expected slowdown in global growth from 3.4% in 2022 to 2.8% in 2023. But as the International Monetary Fund (IMF) expects, the risks are dominant on the downside. If the financial sector is distressed, global growth could slide down further to 2.5% this year.
This scenario places emerging markets like the Philippines in a vulnerable situation. If the capital markets tighten, our debt spreads could widen and FDI as well as portfolio investments could retreat. The dynamics of capital flows could significantly shape the direction and composition of our overall BoP.
As a guide to the future, how did the Philippines manage capital flows during crisis periods?
We got a copy of the BSP’s Economic Newsletter No. 23-01 of January 2023 containing an interesting study, “An Empirical Note on the Philippines’ Policy Responses to Managing Capital Flows: Evidence from the Crisis Periods” by a group of senior economists from the Department of Economic Research namely, Jean Christine A. Armas, Erniel Martin R. Enrile, Ma. Aizl Camille C. Santillan, and Josephine A. David.
They recognized that capital flows contribute to funding economic growth, but large and volatile capital flows could be counterproductive. As we experienced in the past, they could drive the peso to appreciate, inducing excessive bank lending and investment as well as motivating speculative activities that could weaken the balance sheets of business. And there could always be a change in market sentiment and therefore capital reversals could happen. Again, based on past experience, we could travail again with currency crisis, collapse of consumption and investment, and bank failures.
These young economists, drawing from the literature, laid down five potential tools that could be employed by the authorities including 1. FX intervention; 2. monetary policy; 3. fiscal policy; 4. macroprudential policy measures; and, 5. capital controls or what the IMF now calls capital flow management measures.
The paper’s contribution to our greater understanding of our past and the options for the future is its empirical analysis of the effectiveness of those tools as employed in the local context.
By estimating the policy reaction functions for each of those tools, the economists found that the BSP’s FX intervention responded strongly to both FDI and portfolio investments. The BSP conducted this approach by accumulating FX in its GIR and intervening in the FX market. The economists found that its intervention was rather modest, showing that a flexible exchange rate system is the BSP’s first line of defense in managing capital flows. Again, the empirical study also showed that the BSP responded more to net capital inflows than to net capital outflows. The bias of the BSP is clearly against excessive appreciation which could undermine financial stability.
In the case of its monetary policy, the economists illustrated that the BSP has been careful not to readily adjust the monetary levers in the face of capital flows, whether incoming or outgoing with no distinction as to the type of financial capital.
The results also affirm the BSP’s adherence to its flexible inflation targeting framework. Monetary policy responds more to both inflation and output gaps, in that order. Monetary policy also responds to changes in the real effective exchange rate because of its effect on inflation.
It was also found that fiscal policy was a cyclical to net financial capital flows, that revenue or expenditure policies are neutral to net capital flows. Fiscal policy has not responded to the dynamics of capital movements. This was attributed to the very nature of the budget process, that its slow pace is not appropriate in responding to rapid capital flows, lest it worsens its impact on the markets and the economy.
What about macroprudential measures?
The BSP study revealed that these macroprudential measures were used according to the nature of the crisis. They were relaxed during crisis periods, as what happened during the pandemic crisis. Macroprudential measures have been generally deployed to handle financial stability risks due to capital flows.
It’s an excellent assurance by the BSP economists that their empirical work is robust with respect to data selection, sample coverage, and period. Even if the model specifications were changed, the results proved consistent. It’s more reassuring that the authorities pulled the right tools during crisis periods.
But the wild cards remain at play, not the least of which is the uncertain and volatile global situation. The other is what Isaac Newton could say today: “I can calculate the motions of the heavenly bodies, but not the madness of people.”
Diwa C. Guinigundo is the former deputy governor for the Monetary and Economics Sector, the Bangko Sentral ng Pilipinas (BSP). He served the BSP for 41 years. In 2001-2003, he was alternate executive director at the International Monetary Fund in Washington, DC. He is the senior pastor of the Fullness of Christ International Ministries in Mandaluyong.