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By Lawrence Chin, Researcher
(First of two parts)
The country’s inflation rate has been substantially reduced since
the Bangko Sentral ng Pilipinas (BSP) introduced “inflation
targeting” in January 2002. Despite the relative price stability
experienced by the economy, experts are wary that the fragile fiscal
system might undermine the early gains.
After almost two years, the framework has
effectively reduced inflation, averaging 3 percent. This trend was
commended by no less than the International Monetary Fund (IMF), in
its 2003 postprogram discussion with Philippine government
officials concluded last August.
“I think inflation targeting is working for
the country because our inflation has been so low in the past
several months,” declared Asian Institute of Management professor
Victor P. Limlingan as he recalled the two-digit annual inflation
rates suffered by our economy many years ago. “Before, inflation
reached as high as 18 percent and it was so difficult to borrow
money.”
However, experts agree
that the biggest threat to the country’s price stability remains
its fragile fiscal system, consisting of the tax collection system
and the consolidated expenditures of the government. Although the
BSP’s primary mandate is to promote price stability, authorities
know that a large fiscal deficit could influence inflation outlook,
affect monetary policy and diminish BSP’s independence.
“A large fiscal gap could force fiscal
authorities to withdraw from the Philippine government’s deposits
in the BSP or to increase its borrowings,” said BSP Deputy
Governor Amado M. Tetangco Jr.
Once the government withdraws funds from its
account with the BSP, the money eventually finds its way to the
financial system creating inflationary pressures from the
demand-side as money supply increases.
On the other hand, an increase in government
borrowing could hike interest rates of government debts as they
compete with the private sector for funding in the financial market.
In short, large fiscal deficits will eventually threaten price
stability.
“The worst thing that could happen is if there
is a growing inflation due to fiscal imprudence and the government
will try to address that by importing cheap food to dampen the
pressure, eventually causing distortions to the agriculture sector,
“ said Dr. Ponciano S. Intal Jr., an economics professor at the De
La Salle University.
Price stability
National Economic and Development Authority (Neda)
Secretary Romulo L. Neri cited the Filipino people’s reluctance to
pay taxes as a major source of weakness in the fiscal system.
BSP’s Tetangco notes that the tax revenue to
gross national product ratio has declined to 12.5 percent in 2002
from 17 percent in 1997. Meanwhile, collections by the BIR as a
percentage of gross national product fell from 13 percent in 1997 to
just 9.9 percent in 2002.
The National Authority on Revenue Administration
(Nara) bill, that is currently pending in the Philippine Congress,
is a possible solution as it aims to further professionalize the
revenue collection system, said Neri.
He explained that countries that have applied
similar measures have experienced tax collection hikes, with some
even doubling it. However, he admitted the highly political nature
of the bill as the jobs of 12,000 BIR employees could get affected.
Moreover, the Nara bill is viewed with suspicion
by some lawmakers as it is alleged to be a product of the
controversial lobby group called Agile (Accelerated Growth
Investment and Liberalization with Equity), which is funded by the
US Agency for International Development.
Tax review
Intal, Neri, Limlingan, along with the IMF, call
for the review of the specific tax system that they believe is
outdated. In particular, they want to see an increase in the ‘sin
taxes’ for beer and tobacco products.
“Tax deterioration from that source alone
amounts to P40 to P50 billion every year,” said Neri.
On the other hand, Limlingan and the IMF,
believe that oil-excise taxes and value-added taxes must be
increased. They also call for the rationalization of tax incentives
to industries.
“First, with trade liberalization we brought
down tariff and so customs collections have been affected. Second,
the growth industries are the export industries and we usually give
them tax incentives. Third, the other growth industries are
difficult to tax like the call centers,” said Limlingan.
While authorities believe in streamlining
government expenditures, Neri believes that the power sector must be
prevented from bleeding the government’s finances further, and
urged the continuation of efforts to privatize the National Power
Corp. (NPC) and its transmission assets.
The Electric Power Industry Reform Act (Epira),
effective since June 2001, provides the legal framework for the
restructuring and privatization of Napocor. It created two agencies,
namely the Power Sector Assets and Liabilities Management Corp.
(Psalm) and the National Transmission Corp. (Transco). Psalm is
tasked with arranging the sale of Napocor’s generation assets.
Meanwhile, Transco (wholly owned by Psalm) takes care of privatizing
Napocor’s transmission assets to private concessionaires.
Inflation targeting and price stability
According to the BSP, the whole point of
inflation targeting is to focus the government’s economic efforts
to the promotion of price stability.
To a developing economy like the Philippines,
price stability is very important because price volatility could
adversely affect the decisions of people about consumption,
investment, savings, and production. Furthermore, it promotes low
lending rates that could induce more business activity, investment
growth, and employment. It goes without saying that the absence of
price stability delays, if not hampers, economic growth.
In the quest for price stability, the
inflation-targeting framework prescribes, as the key ingredient, the
government’s commitment to maintain a low and stable inflation
rate. This implies that to achieve price stability the government
has to keep the supply of commodities and the levels of liquidity in
proper balance, as “inflation” is the increase in the price of
goods and services due to the shortage of goods, the excessive
supply of money, or the combination of both.
Many countries have experienced high inflation
in the 80s after years of using monetary targeting policy. As low
inflation came as an aftermath to the recession during the early
90s, economists and policy makers around the world began debating on
how to maintain the levels low. Hence, the concept of inflation
targeting was born, and in 1990, New Zealand was the first country
to adapt the framework, even though it was formalized only in 1996.
The BSP has decided to implement inflation
targeting in the country because (1) it is a simple framework for
the public to understand as people could easily see what rising
prices mean to them; (2) it makes the BSP focus on price stability,
which is consistent to its mandate; (3) it is forward-looking or has
delayed effects to inflation; (4) it is comprehensive in its use of
economic information; (5) it promotes transparency through the
public announcement of targets; (6) and, it promotes accountability
by making BSP declare its commitment to the public.
Previous policies
Prior to inflation targeting, monetary policy
lacked focus. In the past, monetary policy has been directed not by
a single economic goal but by a multitude of political motives.
“To generate employment, for instance, the
government used to promote credit to industries but at the same time
sacrifice inflation,” said Neri. “A part of it was to defend the
currency, another part was to ease credit flow to a certain
industry, or sometimes to help the fiscal side. A policy, when used
for so many objectives, no longer becomes effective—it becomes ad
hoc.”
However, the BSP maintained a different opinion.
“It was a good system for that period,” said Tetangco.
Previously, monetary aggregates – like reserve
and base money – were targeted by the BSP in setting the monetary
policy. Through the years, developments like financial
liberalization and new financial products (e.g. derivatives) have
weakened the link between monetary aggregates and inflation thereby
rendering monetary targeting obsolete and paving the way for the
introduction of inflation targeting.
BSP accountability
To properly implement inflation targeting the
BSP has to announce to the public its target inflation and its
commitment to achieve this goal. With this, doubts surfaced on
whether the BSP has achieved honest-to-goodness inflation targeting.
“We are essentially moving toward it but not
really applying it,” said Intal.
Despite the country’s low inflation rate (3
percent last August), Intal pointed out that in other countries
using inflation targeting the central bank governor takes vigorous
efforts in informing and explaining to the public what the inflation
target is, why there is a discrepancy, and what measures are being
undertaken to address the situation.
The BSP lacks transparency and accountability,
Intal said, in the sense that it has not made its target known to
the general public. BSP Governor Rafael B. Buenaventura has not been
made accountable for missing the inflation target, nor has he
explained his action plans.
In New Zealand, the central bank governor has
signed a contract with the government where, in case actual
inflation misses the target, he would be made to explain before the
public and possibly get fired from the job in the event of his
failure to do so.
“But in our case we do not have such a
contract,” said Tetangco.
Tetangco said that the BSP has embarked on a
nationwide information campaign on inflation targeting where
reception from the multisectored audience has been reported to be
positive.
“I do not think we have fully implemented an
inflation targeting system but we are going through the transition
phase and the conditions are there to move closer to it,” added
Intal.
(Tomorrow: Inflation management)
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