Financial Storm Brewing

Ultimately it’s the degradation of domestic agriculture and industry that is making the economy more and more vulnerable. In the absence of a solid domestic economic base, the economy is unduly reliant on external sources of growth and resources. It’s this dependence that is bringing the country to the verge of a financial meltdown.

A US$887 million balance of payments (BoP) surplus was recorded in the first five months of the year. Unfortunately this was a hollow surplus and due wholly to external sources: overseas Filipino worker (OFW) remittances, increased “hot money” and greater foreign borrowing.

OFWs remitted US$2.3 billion in the first quarter of 2005 or 17 percent more than in the same period last year. In terms of the BoP, OFW compensation inflows grew at a faster rate of 4.1 percent compared to 2.4 percent last year. Yet notwithstanding that OFW remittances are the most important economic lifeline for millions of Filipino households, this is essentially a source of resources external to the economy and beyond its control that, as a fundamental surrender of economic sovereignty, should not be made a long-run pillar of the economy. There are moreover the very serious social costs involved for OFW families.

It’s the other two sources that will be the source of problems for the Arroyo administration. Portfolio inflows accumulated to US$1.913 billion as of the third week of June or some 14 times the amount posted in the corresponding period last year. The government meanwhile has so far for the year been able to issue US$2.3 billion in sovereign bonds.

With foreign direct investment (FDI) dropping steeply – Bangko Sentral ng Pilipinas (BSP)-registered FDI shrank by 73 percent in the first quarter compared to the same period last year – “hot money” and public foreign borrowing have been crucial sources of foreign exchange. Yet these two sources are also the most dependent on investor and creditor perceptions and so most vulnerable to suddenly reversing depending on how the overall political and economic situation plays out.
Arroyo’s financial storm

Ms. Arroyo apparently is opting to ride out the storm battering her administration. Unfortunately the concrete economic and political conditions are working strongly against her.

Although the government plays up improving national government (NG) budget deficits, at the end of the day the consolidated public sector deficit (CPSD) is still high and rising. In the first quarter the CPSD was 10 percent higher than in the same period last year. As long as there is a deficit, borrowing will continue and debt will increase.

By April, total NG debt was still 11 percent higher than a year before. End-2004 outstanding public sector debt was still at PhP5.3 trillion or 118 percent of GDP (although this figure is questionable). Total NG debt payments in the first four months of the year were 20 percent higher than the year before and total 2005 debt payments are projected to eat up 94 percent of total revenues.

Compounding the administration’s troubles is the expanded value-added tax law that basically translates into a great additional burden on the already so overburdened populace. Ms. Arroyo’s attempt at fiscal adjustment by placing the burden on the people can only backfire against her and bring the economy into greater crisis.

The Arroyo administration’s grave crisis of legitimacy dovetails with all of these weaknesses – a backward domestic economy, absence of any popular support, reliance on external sources of finance and high levels of debt and debt payments – to lay the conditions for a financial storm.

As the political tumult grows, opportunistic foreign investors and creditors will increasingly realize that the “economic stability” they yearn for will not be possible under a beleaguered Arroyo administration. Interruptions in foreign lending to the government and in “hot money” inflows will precipitate a foreign exchange crisis.

An export-dependent and import-oriented economy is deeply vulnerable to such an arbitrary external shock and interruptions in foreign payments flows will cascade across the entire domestic economy. Especially with a government unwilling to take the radical economic reforms needed to get the support of the people and build a strong domestic economic, the economy could be plunged into turmoil.

Ms. Arroyo’s stubborn attempts to cling to power and ride out the storm may, on the contrary, bring about a much greater storm. Bulatlat

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