The Maharlika Fund: A Pricey Stud Or A Milking Cow?

Congress and the Executive branch are excited over their latest brainchild: The House is about to approve in record time the creation of the Maharlika Investment Fund, a Government vehicle that will invest in local and foreign private and public enterprises. The MF will be chaired by the President or his designate, with the head of the GSIS as Vice-Chair and other Government officials as Directors.

The stated mission of the MIF is “to reinvigorate job creation and reduce poverty”. The Maharlika Fund (MIF) is said to parallel sovereign wealth funds in among others Saudi Arabia, Norway, China and Singapore. The MIF will start with a P250 billion kitty to which the Budget will contribute P25 billion annually, GSIS P100 billion, SSS P50 billion, DBP P50 billion; with PAGCOR (10% of its gross gaming revenues) and BSP (50% of its dividends) to follow. The investments by the GFIs in the MIF shall be guaranteed by the National Government.

The Maharlika Fund is, with all due respects, a really bad idea. Here is why:

1.The MIF will not help the economy; in fact it will do the opposite – The MIF will be allowed to invest in foreign entities as part of its mandate. In effect the MIF will divert scarce Philippines savings to buy foreign stocks and bonds. To tell you how crazy that is President Marcos is flying around the world courting foreign investors to invest in our country yet here we are mandating our Treasury and GFIs to invest offshore.

2. The MIF has no added value – The MIF will be duplicating functions already being done by our GFIs without any assurance it will do a better job. The MIF is a cross between what Wall Street calls a Special Purpose Acquisition Company (SPAC), a publicly listed vehicle with no plans and no purpose other than a promise of riches; and a hedge fund with an unconstrained mandate. Most of the SPACS have collapsed including one involving Donald Trump. Over 80% of hedge funds under perform the market. Why will the MIF do better?

3. The Philippines has no savings to reinvest – Countries with sovereign wealth funds like Saudi Arabia, Qatar, Kuwait and Norway have petro-dollars that need to be re-cycled. The Philippines has no such surpluses. In fact we will be borrowing to finance the Government’s contribution to the MIF at a time of limited fiscal space. The annual contribution of the Treasury of P25 billion could be better spent on education and social amelioration.

4. Our Government has a dismal record in managing money – Our economic landscape is littered with the carcasses of Government funds that promised everything and delivered nothing. In 1971 Ferdinand Marcos legislated the infamous Coconut Investment Fund by imposing a P0.55 levy for every 100 kg of copra. The money was to support coconut farmers but ended up allegedly financing the take over of San Miguel Corp. by one of the cronies. The ownership of the Cocofund is today still being disputed in court.

The Coconut Fund also financed the United Coconut Planters Bank. UCPB got into trouble and had to be rescued by a merger with LandBank.

The National Development Co. (NDC) was another funding vehicle established by the first Marcos Government to support investments. The NDC is now a skeleton of itself with a sprinkling of real estate holdings. The NDC is so moribund its website does not even list a General Manager.

Then there was the Government managed Road Fund, a levy on private motor vehicles to support our infrastructure. This tax is the third largest source of Government revenue after the BIR and Customs. In 2009 Sen. Miriam Santiago exposed P61 billion in anomalies in the Road Fund. God only knows what has become of that disaster since.

Philhealth was established to finance universal care in the Philippines. In 2020 Philhealth was discovered to be some P200 billion in the hole from massive corruption. None of its officials were jailed.

The Maharlika Fund will I believe suffer the same fate as the others. Only this time the victims will be the SSS and GSIS pensioners, the Landbank, the DBP and the Filipino taxpayer. The authors of the proposed MIF bill claim there will layers upon layers of Government oversight but the same was said of the other funds that collapsed. With the President as its Chair who will dare challenge the governance of the MF? There will be independent directors in the MIF and an external auditor to protect the public interest but we all know how that works.

5. The MIF is fraught with risks – Congressional authors of the MIF bill claim the GFIs will have “zero risk” because their investment will be guaranteed by the National Government. What they do not tell us is any claim on the Government guarantee will ultimately have to be paid by taxpayers.

6. The Landbank, the DBP and the BSP have no business investing in the MIF – The Land Bank is supposed to support the agricultural sector, the DBP the commercial and industrial sector. How does their investment in the MIF help further their mission?

The BSP is an independent body established to protect our financial system. Why should 50% of their dividends be plowed into a fund over which they have no say? When asked if the BSP would contribute to the MIF, Gov. Felipe Medalla said he will do so only under duress or words to that effect. He was concerned about possible anomalies in the Fund: “The experience of 1MDB in Malaysia is the biggest risk”. Finally, a man who speaks to the truth .

7. The MIF will not attract foreign money managers as its sponsors claim – Foreign managers will not invest in a vehicle that simply replicates what they do especially given our country’s record in that space.

The truth is the Maharlika Fund is likely to be yet another political slush fund to support the new cronies just like the Coconut Fund was used to support the old cronies. But this time it is the pensioners and the ordinary taxpayer who will take the hit. The MIF will fly under the scrutiny of regulators, the media and the public. Under the proposed draft bill that I saw the control mechanisms on GFIs and GOCCs will not apply to the MIF. Employees of the Fund will not be subject to Government Salary Standardization limits so its officers and directors can be paid enormous benefits. The MIF will be excluded from Government Procurement protocols.

Filipino taxpayers and pensioners will end up footing the bill, writing a P250 billion check to an entity with no investment program, no track record and no mission other than motherhood statements like “to reinvigorate job creation and reduce poverty”. No one has explained how making investments abroad through the MIF will do that.

The MIF looks to me like a fattened cow waiting to be milked. We have seen it elsewhere: 1MDB, the Malaysian Sovereign Wealth Fund, was scammed of four billion dollars by the then Prime Minister and his wife aided by a prominent U.S. investment bank.

If the bill becomes law the Maharlika Fund could well become the mother of all heists.

The BSP Must Stand Firm 

 The BSP is the independent body tasked by the Constitution to oversee monetary policy and regulate our banking system. It does this by controlling the supply of money, adjusting interest rates and stabilizing the peso through open market operations. In times of crisis the BSP is the last bastion for  protecting  our economy. Its independence shields it from interference by the Executive and Legislative Branches of Government.

It is therefore disturbing that in recent weeks the Executive Branch has started to speak for the BSP rather than this institution speak for itself. Thus the President announced that “the peso will be defended”. In chorus, DOF Secretary Ben Diokno chimed in stating the BSP will intervene in the foreign exchange market to the tune of $10 billion of our international reserves at a target price PHP60/USD. Diokno also said the BSP would raise interest rates by100 basis points. Sec. Diokno was the previous BSP Governor so perhaps forgot he is no longer so. There was no official reaction from BSP Governor Felipe Medalla but I would not be surprised if he was livid that others – whoever they be – are now in his lane.

Shortly after the pronouncements of the President and Diokno the peso dramatically strengthened from around P59/USD to around P58/USD, a massive move whose speed and size could only be explained by the BSP intervening in the market possibly at the behest of Malacanang. The peso rally however was short-lived with the peso quickly weakening to near previous levels. This proves that a) no institution is bigger than the market and b) currency intervention unaccompanied by economic fundamentals is unlikely to succeed. Japan’s central bank has spent $42 billion to prop the yen with little to show for it.

The U.S. is another example of what happens when a central bank succumbs to a Government’s signals to artificially stimulate an economy. Convinced that inflation was “transitory”, the U.S. Fed expanded money supply by over 25% fueling a 40 year unprecedented rise in prices. The consequent inflation has now come to haunt the Biden Administration with Democrats expected to lose control of the House and possibly the Senate in next week’s mid-term elections. 

It is not easy for Gov. Medalla to resist the President and his predecessor when they make pronouncements which only he is constitutionally entitled to do. Medalla was appointed by the President likely upon the recommendation of Diokno so he is indebted to them for his position and the PHP 42 million remuneration that comes with it. His term expires next year which adds to the pressure on the BSP Governor to play ball with the Administration.

Yet now more than ever is when the BSP must exercise its independence.

The Philippines has a debt of over PHP 13 trillion of which some 30% is in foreign currency and 70% in pesos. Our inflation is now 7.7%, a near 14 year high.. Our trade deficit of $47 billion has grown by 63% from a year ago with further prospect of deterioration as prices of critical commodities like oil and food remain elevated from geo-political conflict and climate change; and interest rates climbing. Our international reserves have dropped from $103 billion early this year to $93 billion. As our economy grows our demand for imports of machinery and raw materials will rise widening our trade gap and pressuring the peso. In this scenario of tighter world financial conditions, continuing inflation and higher trade and budgetary deficits the question becomes how do we finance ourselves?

With our credit rating the Philippines can still access the international debt market but this is going to be more expensive and harder to do. Foreign investors are increasingly wary of emerging market( EM) debt. A number of EM countries are now in serious risk of default which contagion will spread even to better quality borrowers like us. Interest rates worldwide are rising. The Philippines just had to pay 200 basis points more on its last $2 billion international bond offering which is more than 60% of what it paid earlier this year.

In the absence of higher taxes which Sec. Diokno has rejected; the answer to our financing gap must be by borrowing more locally in pesos. This will crowd out private businesses which will slow the economy. To avert this there will be a temptation to increase the money supply to fund growing Government expenditures but this will debase our currency. If uncontrolled this will lead to a spiral of more inflation, a weakening of the peso and yet more inflation. The only guardian of our economy in this scenario of cascading price increases will be the BSP so its independence becomes crucial. Does the BSP Governor have the fortitude to hold his ground?

Medalla has remained relatively silent in the face of the weakness in the peso leaving DoF Sec. Diokno to speak for him. Only when analysts bewailed his absence has he stepped to the podium to push back. He has rejected Sec. Diokno’s strategy of drawing a line in the sand on foreign exchange intervention preferring instead “more flexibility in efficiently managing our foreign exchange reserves”. He also announced a 75 basis point increase in interest rates against Diokno’s suggestion for a 100 bp increase. 

 People who know Gov. Medalla say that despite his mild manner, the man has the backbone to protect the independence of the BSP. He is seemingly less political than his predecessor which gives comfort. However he can often be obfuscating as when he pronounced: “We don’t want to sell so many dollars to defend the peso so the best way to do that  is to let the market know what we want to do”. This may be his way of giving forward guidance but it should be accompanied by real measures such as limiting banks’ overbought dollar positions or suggesting to Congress and DoF Sec. Diokno a tax on windfall FX profits of banks. The Q3 financials of banks are reporting record profits possibly from FX positioning.

We are seeing some steeliness in Medallla to take on, unconsciously, even the President. He recently bewailed the Government’s efforts on the economy:  “The BSP continues to strongly urge the timely implementation of non-monetary government interventions to mitigate the impact of persistent supply side pressures on inflation”. Although perhaps unintentional this spoke to the President’s failure as head of the Dept. of Agriculture to increase food production.

The President reportedly does not take criticism lightly however constructive. We hope Medalla’s forthrightness is taken by BBM in the spirit that it was given. It is time Government officials speak frankly to the truth for only then can we move this country forward.

Maybe It Is Not The Peso That Needs Fixing

The talk of the town is the Philippine peso which has devalued by 15% in the last year, reportedly among the worst in the region. President Marcos publicly committed to protect the peso as has DOF Sec. Diokno. Rep. Sandro Marcos weighed in stating correctly the peso weakness is partly dollar induced.

The concerted talk tells us a) there is a problem and b) there could be worse to come. DOF Sec. Diokno vowed to defend the peso at P60/USD with a $10 billion war chest. Drawing a line on the sand and disclosing the size of the ammunition can be dangerous. One, it invariably means the peso will eventually move to that level. Two, once breached nobody will believe you after that.

Right now the peso is holding at around P59/USD with BSP intervention but it is unclear how long that will last. In August we posted a trade deficit of $6 billion, the largest single month figure since 1957. Our Jan-Aug.deficit was $42 billion, 68% higher than a year ago. Our foreign exchange reserves dropped from $108 billion six months ago to $93 billion. Philippine inflation rose to over 7% in Sept. its seventh month in a row.

The Philippines completed a $2 billion USD bond offering at an interest rate 200 basis points higher than our last loan. Our interest bill is heading higher.

In July 2022, NEDA Sec. Arsi Balisacan said: “The Philippines is far from stagflation”, the dreaded combination of inflation and economic stagnation. Arsi now says: “We are monitoring the developments closely. We can also deploy our monetary tools like interest rates so we can intervene in the financial markets to obtain these included in the weakening of the peso.” I am not sure what he meant but it sounds ominous.

He reiterated that “rising inflation is temporary”. This mirrored what the Fed Chairman said last year of U.S. inflation and he is now having to eat his words. Not only was Powell wrong, he lost his credibility which partly explains the volatility and over 20% drop in the stock market this year.

Defending a currency is a tricky thing. It involves three things: One, credibility. Our leaders are trying to talk the peso up but will not succeed unless the markets believe our Government is doing what it needs to finally fix our economy. Two, having the ammunition to successfully intervene. The announced $10 billion budget (11% of our international reserves) may sound like a lot but is not when faced with the power of the market. Three, an element of surprise. The BSP should not telegraph its intervention price nor the size of its war chest. Once these are known the market will position accordingly.

If these don’t work the BSP may impose increasingly harsher capital controls which is the road to perdition. Foreign investors head for the exit, the locals panic leading to a run on the currency. This fuels inflation which just adds to the problem.

The only way to halt a slide in the currency is to get the markets on side. Once investors believe in our actions – not our words – the sentiment will quickly change. The British pound, the gilt market (the U.K. version of U.S. Treasuries) and the Truss Government collapsed last week after the latter promised to cut taxes. However the British pound reversed itself as soon as the change in policy and Government were announced. 

How do we get the markets to believe in our economy? Here are possible solutions some worst than others:

1.Stop the corruption – This is more effective than a $10 billion forex war chest. It will restore investor confidence.

2. Defer the corporate tax cuts under CREATE- Studies in the U.S. and the U.K. show tax cuts do not result in additional investment or productivity. They simply go to higher dividends and share buy backs benefitting the rich not the poor. Our monetary and fiscal policies are now at cross purposes when they should be moving in tandem: The BSP is raising interest rates to quell demand while the DOF cut taxes to propel demand.

3. Impose a tax on super-profits – Some companies have benefited disproportionately from the peso devaluation and the accompanying inflation. In the U.S. a tax on oil companies is being considered, in the UK a tax on banks. Some local companies in the extractive industries and banks with unusual forex profits may fall under this category.

4. Realign the Budget – The 2023 Budget contains monies for among others an Intelligence Fund for the Office of the Vice-President (to establish provincial OVP offices) and the DepEd (to track criminals preying on the young). Is Sara building a state within a state? The DepEd needs money for the intelligence of our kids not for that of the OVP however lacking. Then there is some reported P370 billion in Lump Sum Appropriations which is the politically correct term for Pork Barrel. The money saved could go to social amelioration.

5. Prioritize the low lying fruits while building for the future – In the short term we should go all in on dollar earners like tourism and OFWs where the benefits are immediate and the capital investments modest. This involves a unified approach by all the stakeholders – the hospitality industry, airlines, local and national Government and our international outposts – targeting the Filipino diaspora and foreign travelers. We should upgrade OFW skills to address the world needs for mid level workers e.g. in airport ground handling. 

In the medium term we should build our infrastructure, education and agriculture.

6. Tighten our belts – Government needs to cut costs and dispense with frivolities. We should start with a freeze on new hires while we study how we can deliver the same services with less. We must dispense with public displays of ostentation whether funded privately or publicly.

7. Stop relying on interest rates alone to fix the problem – This is what happens when monetary economists are asked to address a problem. We need a holistic approach to inflation. One needs a bazooka to stop an onslaught, not a single shooter.

8. Wield the stick – SMC Power recently threatened to cancel their energy supply contract with Meralco because of some P 15 billion in annual losses from the fixed price arrangements. This will result in a loss of energy supply at a time of looming power shortages. The Government cannot allow it to happen: SMC Power seemingly made a commercial error in agreeing to a fixed price contract but the consumer cannot be made to pay for it. There could be a compromise where everybody agrees to take a hit under some form of Ch. 11 protection; in the interest of national security. The case of Manila Water comes to mind.

9. Increase the Conditional Cash Transfer program in an efficient way – Research has shown that CCTs are the best way to provide social relief. The problem is that like Ayuda most of it gets caught in the bureaucracy and corruption in the fund administration.

10. Raise the minimum wage – This is a political solution to an economic problem and will not work given our high unemployment and under employment. 

11. Price ceilings – This is generally a bad idea except in instances of clear price gouging. Even then the solution is not in setting a price cap but in punishing those operating in restraint of trade.

11. Moral suasion- This includes persuading banks to lighten whatever their overbought dollar positions which is hurting the economy. This could help for while.

11. Do not politicize the problem – A senior economic manager called our economic problems “easily manageable”. Our leaders must not lose the public’s trust with statements that defy reality.

Defending the peso through outright intervention is a one dimensional, end-of pipe solution. It could deplete our international reserves without addressing the underlying issues like focusing, aligning our fiscal and monetary policies, living in austerity and addressing gut concerns like corruption. These and not the peso are arguably what needs fixing.

A Presidency Still Finding Its Way

Barely 100 days into this Administration and already we have seen a major shakeup in  Malacanang. Last week Executive Secretary Vic Rodriguez resigned from his position “to look after his young family”. Got it. Press Spokesperson Trixie Cruz- Angeles followed suit again for “personal reasons” but more likely as part of a purge in the Palace of anybody that walked, talked or smelt like Atty. Vic. To smooth ruffled feathers the President was reportedly to appoint Atty. Vic as his personal Chief of Staff but this crazy plan was abandoned after vigorous objections from Palace insiders notably from one Atty. Ponce Enrile, 98, the Presidential Chief Legal Counsel; and family members. Why the President even considered such an option tells us he is loyal to his people almost to a fault.

Atty. Vic’s case was a brazen power grab gone wrong. He wanted to control all aspects of the presidency but, worse, being the lawyer that he is, he wanted his job description in writing. Wrong. If he had simply kept his head down, stayed in place and not bother with the legal niceties he could have been, unnoticed, the de facto President. Atty. Vic must have sensed BBM was allowing him the run of the Palace which says as much about the President and his judgement of character as it does about Atty. Vic. Unfortunately the latter ran into JPE, a seasoned power player who can smell a rat even before he sees one.

COA Chairperson Jose Calida also stepped down but this time for the real reason of a medical condition. Calida reportedly had not been reporting to office on a regular basis.

Ex-CJ Lucas Bersamin, 72, was appointed ES to replace Atty. Vic. Bersamin was one of nine Justices who voted to allow Ferdinand Marcos Sr. to be buried in the Libingan ng mga Bayani. At his age Bersamin is probably a place holder. The musical chairs of power is still not over.

In this flux JPE has come to assume a major role in the Palace both in key appointments and direction – he is said to have 3 offices, one beside the President’s, one beside the ES’ and one in the PSG. JPE is proving a much needed ballast to the Presidency at a time when the country is headed for trouble. I will not bore you with the details, just believe potentially scary stuff is coming down.

How we survive the gathering economic clouds depends on the leadership of the President and his management style. Unfortunately not much is known about these. In the Senate BBM remained fairly obscure and even today likes to stay on message and not reveal his inner thoughts.

There are varying assessments on BBM. Duterte described him as a weak leader but that was in a fit of anger. Sen. Imee has described her brother as chill. Others say he “actually is a nice guy”. Critics admit he is less scary than expected. He is intelligent, poised and capable of properly representing the country in international forums like the ASEAN and the United Nations. He is personable and prepared to listen as evidenced by the recent Palace house cleaning. The question is does he have the focus and ability to instill fear needed for an effective presidency?

BBM can talk the talk but can he walk the walk? So far the President has displayed a limited range. This is partly due to his natural conservatism – he is not a risk taker both in policy and in choice of people – but also to the heavy legacy he bears. BBM is aware the eyes of the world are on him so he is mindful to tread carefully less he be seen to repeat the sins of his father. This legacy makes him distrustful of people which limits his reach. BBM and Liza have kept to themselves all these years and have few close friends mainly social. He has relied heavily on the confidantes of his Dad like JPE and on recycled technocrats with no alternative agendas. Unfortunately many of them are getting long on the tooth and will need to be replaced sooner rather than later. 

The failure of BBM to cast a wider net is also that many otherwise qualified candidates were reluctant to serve a President who until this date remains guarded on his future intentions. They are unwilling to risk their reputations to sanitize a BBM presidency until they know more but more is not forthcoming.

BBM may have a vision for this country but has not articulated it clearly nor is he consumed by it. He has not been emboldened by 32 million votes to go all in on his presidency but has instead almost taken it as a cushion to go slow and easy. BBM has also made a few rookie mistakes. His trip to the Singapore F1 may be deserved after 3 months in office but the optics were horrible: One,the President is supposed to be promoting Philippine tourism, not Singaporean tourism. Two, watching gas guzzlers hurtling around a race track when Filipinos are strangled by soaring fuel prices is shall we say insensitive.

The upshot of all this is an Administration that has still to find its footing. BBM has not yet appointed people to head critical agencies like Health and Agriculture. The President has appointed himself as Sec. of Agriculture to signal the importance he assigns to the sector. It is a bold move but not practical as evidenced by the SRA fiasco. If that could happen so soon and right under his nose then how much more on a national scale.

The first 100 days is the traditional honeymoon period of an Administration. The best that can be said of this Government is it has been uneventful, just some hand holding and sweet little nothings. The natives may soon be getting restless particularly with trouble at our doorstep. What the President needs right now is a major initiative that will excite the nation and distract from the everyday problems of Filipinos. That is unlikely to come from the economy where the problems are just too many to be resolved quickly. What he needs is an initiative that the people can relate to, is politically and economically powerful, that will prove his sincerity and commitment, and that can be launched immediately. That initiative is a War on Corruption.

JPE would be the perfect person to lead such an initiative. At his stage in life he has more money than he can enjoy. What he might value more is to leave a legacy to what has often been a controversial career, to be the new sheriff in town, the Elliott Ness that finally cleaned house. He was the chief enforcer in the Marcos’ first presidency so he could do the same in the second. He could have at his disposal the Php 4.5 billion presidential intelligence fund that could finally be put to good use. JPE could also tap the manpower and skills of the National Intelligence Coordinating Agency to infiltrate the various hot beds of corruption in Customs, the LTO and other money making agencies to ferret out the rats.

If carried through a War on Corruption would dispel all notions of a weak presidency and be the catalyst for the various reforms needed in this country.

Possible Lessons From PAL

“ A crisis is too valuable to waste.”

The Philippines is facing serious economic head winds amidst a turmoil in world financial markets. The prospect of a global cataclysm may be small but even a 10-15% probability should not be discounted. After all what was the probability – bad or good – 1 year prior to the event of (i)  a pandemic freezing the world for 3 years (5%?); (ii) the invasion of Ukraine (10%?); or (iii) BBM becoming President (15%)? With globalization any economic or geopolitical ripple could build to a perfect storm. Bank of America warns credit markets today are at their “borderline critical level”. The continuing rise in the dollar and U.S. interest rates together with say a nuclear escalation in Ukraine could trigger a freeze in global liquidity and a sell off in all risk assets. First to fall would be emerging market economies which borrowed mainly in dollars and are dependent on worldwide growth. The liquidation has already started with the index of EM debt dropping by a record.

How do we prepare for such a shock? There is no playbook because unlike the previous crisis in 2008 and 2012, overextended Central Banks in overinflated economies today have all run out of ammunition. One way is to look at how distressed companies turned themselves around and see if this applies to our economy. Companies and economies are obviously not comparable e.g. economies cannot seek Ch. 11 protection; but many of the rescue principles are.

The biggest near corporate bankruptcy in the Philippines is Philippine Airlines. Having been deeply involved in the turn around of the company I believe we as a nation can learn from the PAL experience. 

PAL has always had its share of problems but when the 2019 pandemic and travel lockdowns hit it became clear that unless something was done and quickly the airline as with many other airlines in the world would collapse. PAL’s principal shareholder, Mr. Lucio Tan, had to decide whether he should save a company so vital to the economy. In 2018, 2019 and 2020, PAL lost  a total of over $1.6 billion. The company had a capital deficiency of $1.4 billion by end 2020. Mr. Tan took the gamble.

 In Sept. 2021 PAL filed for Chapter 11 protection to stave off creditors while PAL re-organized. PAL re-emerged three months later, possibly a record time. By comparison Hertz-Rent-a Car took over 18 months to exit a similar proceeding. The NY Ch.11 judge lauded PAL for the harmony, clarity and order of its filing. The PAL rescue was voted the World Restructuring Plan of the Year. Despite record fuel costs, in 2022 the first year of its re-emergence, PAL Holdings, the listed parent, reported six month profits of Php 3.6 billion, a Php 20 billion reversal from a loss of Php16 billion in the comparable period in 2021. PAL has repaid $278 million of debt (Php 16.4 billion) so far this year as it continues to deleverage.

What can we learn as a country from the PAL experience?

1. Recognize the problems early, build a plan that all stakeholders will buy into – PAL prepared a detailed rescue plan. Each flight route was examined for profitability. The airplane fleet and seat configurations were tweaked to serve a leaner network. A vision was laid out of a new and improved airline leveraging the strengths of its transpacific flights to SFO and LAX. Lesson: Government should design a strategic plan that leverages our competitive advantages – a young English speaking population, our natural geography – and allocates scarce resources to the best common good. 

2. Build trust – Trust is the foundation of every re-organization. PAL built a consensus among its stakeholders – employees, creditors, shareholders – by being frank and open with its limitations. The Tan family asked independent directors to chair the critical Governance, Audit, Risk and Restructuring committees to show accountability. Lesson: Our country is divided. We have become tribal. We are a nation not of Filipinos but of Pinks, Reds and Yellows. The people are wary of Government: They are afraid of the police; they believe politicians are corrupt, they are skeptic of economic promises. The primary task of Government should be to restore Filipinos’ faith in Government and each other because everything else – economic growth, peace and order – will follow.

3. Take a reputational risk – Lucio Tan took the risk that a PAL Chapter 11 filing would not cause banks to call in their loans to his other companies. He was right. Lesson: Although an investment grade is important we should not be hostage to it if it means doing the right thing for the Filipino. If we do what we need to do our credit rating will return. 

4. Share the burden – Ch. 11 is an exercise in brinksmanship but also one of collaboration among stakeholders with conflicting interests. Despite the layoffs, PAL employees rallied behind the company. Some creditors balked but in the end essentially all signed off to a $2 billion haircut. For a long time Board directors received no compensation. Management agreed to reduced salaries. The Tan family did its share by injecting $505 million in new money. PAL did not borrow a single peso from Government even as other airlines were receiving billions from theirs. Some private banks stepped in with new loans dispelling the reputational risk that many feared. Lesson: If stakeholders believe in the vision they will accept sacrifices: Businesses will (reluctantly) agree to higher taxes, workers will accept industrial peace, citizens will strive, new money will arrive.

5. Communicate –  Restructuring is largely about the credibility of management and shareholders. PAL management held regular town hall meeting with employees. Creditors were constantly informed. Despite the absence of a Government bail out PAL apprised Malacanang, the DOF and all involved agencies of developments. Lesson: Government should level up with the nation. It should not spin bad news nor exaggerate good. Filipinos can take dire warnings of hardship, what they cannot accept are empty promises like Php 20 rice and dashed hopes. 

6. Work as a team –  The PAL turn around was a collective effort of employees, the Board, management, creditors  and shareholders. Lesson: BBM should put substance to his call for unity. Government should stop the red tagging of food kitchens, the imprisonment of critics and the killing of responsible journalists. Trollers should be asked to stop their divisive posts.

7. Stick to the basics, leverage your strengths, invest in critical infrastructure, execute – With its back to the wall PAL returned to the basics: PAL cut costs, it enhanced its trans-Pacific crown jewels, it is strengthening its information system (MIS). It is working on its Mabuhay loyalty program. The work of PAL is far from done, it must replace its ageing fleet and continue to improve its customer experience; but now there is a way forward.  Lesson: Government should return to the essentials of governance. It should streamline the bureaucracy starting with a freeze on non-essential new hires. Government should protect and enhance its key franchises by upgrading the skills of its OFWs and BPOs, go all in on tourism,  invest in a MIS and not rest until the job is done. It should address corruption. 

8. Bring in fresh blood – Professionals were brought in the airline. The PAL Board was reconstituted one third of which were respected independent directors. Lesson: The country needs fresh energy and thinking. Same old, same old is just more of the past.

In every crisis there is an opportunity. Without the backdrop of the pandemic PAL may not have succeeded in its restructuring. COVID forced the stakeholders to accept sacrifices. Similarly the Philippines could use the current world financial turmoil to take a hard look at itself. PAL can still do more but has already proven this, that if we as a nation stay focused on the prize, work on the processes, trust in ourselves and each other, and share the sacrifices; we should be able to build back better and stronger.

(The writer is an independent director of PAL since Dec. 2020 and member of its Restructuring Committee. )

The Peso: Quo Vadis?

“When the U.S. sneezes the world catches a cold.”

The Philippine peso ended last week at a historic low of 58.75/USD a breath from the psychologically important level of Php 60/USD. It is a 16% devaluation from the start of the year.

The fall in the peso is due principally to the strength of the dollar rather than a weakness in the peso. Most other currencies are experiencing a similar fate: The euro, the Japanese yen, and the British pound are down over 20%. For the first time in 24 years Japan was forced to intervene to defend the yen. The dollar is not only considered the safest haven currency in a world of growing political tensions, it now also offers some of the richest yields among reserve currencies.

Exchange rates depend on a number of factors – comparative rates of growth, trade deficits, and risk sentiment – but largely on the relative level and speed of changes in interest rates and inflation. The U.S. Federal Reserve just raised its funds rate by 75 basis points for a total of 300 this year, more even than during the financial crisis of 2007/08. There could be some 150 bp still to come by year end bringing the Fed fund to 4.5%. At this level the U.S. stock market could drop by another 10-15%. The Fed is adamant about fighting inflation now running at over 8%, well above its target rate of 2%.

Locally the BSP just raised interest rates by 50 bp to keep up with the U.S. and prevent the peso weakening any further and faster; but this was largely ignored by the market. The BSP is perhaps seen to be, as with many of our economic policies, behind the curve, of being reactive rather than pro-active in anticipating head winds. Four months ago when inflation was below 4% then BSP Governor Ben Diokno predicted the peso would hover between 50-54. Inflation however under reported is now officially over 6% and the peso where it is. Our economic team continues to assure us all is well.

The Philippines faces challenges of its own including corruption, an imbalanced economy and a PHP 13 trillion sovereign debt in a period of rising interest rates and limited fiscal space. The Administration is fighting the first with silence – corruption remained unmentioned in the SONA and the U.N. speech – even as it surfaced at the heart of the President’s Office. The supposedly erring official resigned but was promptly appointed to a similar role but closer to the shadows where he can move unnoticed. The audacity of it all is simply amazing.

On our debt every 1% rise in interest rates adds 130 billion to debt service exceeding the entire budget of the Dept. of Agriculture. At the same time every one peso devaluation I estimate adds PHP 40 billion to our dollar obligations crowding out money badly needed for infrastructure, health, education, agriculture and social welfare.

There are some positives to a weak peso. With $60 billion of annual remittances OFWs and BPOs benefit by Php 60 billion for every one peso devaluation encouraging local consumption. On the other hand a 1% induced inflation erases Php 200 billion from our Php 20 trillion economy. By this measure a one peso devaluation is net positive for the economy as long as it does not trigger more than a 0.25% rise in prices.

What can our authorities do to stem the fall out from a weak peso, higher interest rates and inflation? Historically our Government has relied on fiscal and monetary policies to manage the economy but these are insufficient in scope. They may help determine the level of economic activity but not its direction nor distribution. As a result through the years we have mis-allocated our scarce national resources by encouraging imports versus exports and consumption versus investment especially in critical areas like agriculture and infrastructure where the paybacks are long and the going heavy. We are told economic growth will solve all our problems but growth itself adds pressure on the peso as imports for capital equipment and raw materials widen our trade deficit.

The BSP has an unstated mandate to stabilize the peso by intervening in the market. However it has seemingly abandoned any such pretence. It believes our currency weakness is externally induced so any peso support is a waste of our precious dollar reserves. However if allowed to continue unabated, if speculators believe the BSP will not stem the tide, they could aggressively sell down the peso. This will lead to inflationary and currency expectations which once embedded are hard to reverse. Once the markets believe that inflation and peso weakness are here to stay we could have a self-perpetuating spiral with a weak currency leading to inflation, higher interest rates and slower growth and further devaluation. There could be a run on the currency, foreign portfolio investors will rush to the exits, locals will panic and capital controls may be introduced spooking our dollar creditors. The accompanying social unrest could add to the fuel. It would be ironic if a second Marcos presidency was to repeat the foreign exchange crisis of the first with the then Binondo Central Bank and credit default.

Our economy has suffered by failing to develop a long term strategic plan that focuses on our core competence of a young population and God given geographical beauty. Instead we relied on non-sustainable activities like real estate which offered easy returns and impressive macro-economic growth at the expense of urban density. With the unholy alliance between politics and business we erected tariff walls to protect inefficient industries. We did not invest in R&D in manufacturing and agriculture making us among the weakest economic player in our region. We never learnt to compete globally.

 OFWs and BPOs have kept the country alive but we failed to climb the value chain by improving the education, skills and communications levels of the Filipino. This puts us at risk of being displaced by countries which are sharpening the quality of their workforce. Tourism is a low lying fruit but we never fully supported the sector with the needed infrastructure and environmental protection.

There are tough times ahead whatever our economic managers tell us. And worse could come if blind-sided by a Black Swan such as a world liquidity event.

If the dollar continues its climb, if inflation remains sticky, if interest rates rise unabated, if stock markets dive from recessionary fears, if political tensions tighten, if Europe goes into a winter freeze from an energy crunch, if China re-enters a COVID lockdown, if food and key commodity shortages threaten, if climate change worsens; there could be a crack in the world order and a squeeze on international credit markets similar to the 2008 financial crisis. But more important – and this is where it gets scary – unlike previously this time over extended Central Banks will not be able to offer bail-outs by printing money. 

There are fissions starting to appear in the global financial system. The first victims of a credit crunch and a strong dollar will be emerging market (EM) debt where credit spreads have already widened. Sri Lanka has officially defaulted, flood stricken Pakistan is on the borderline as are Egypt, Argentina, Turkey and some drought plagued African nations. Malaysia has been talked about. In a credit squeeze EM countries will be hard pressed to renew much less access new loans.

The Philippines is still not on the endangered list. The resilience of our OFWs and BPOs, the tenure and composition of our debt and our credit rating have kept us in good stead but this could rapidly change if there was a global collapse and all financial assets other than triple A were sold down. Unable to refinance except possibly at atrocious rates we would be forced to drawdown on our dollar reserves putting further pressure on the peso and on inflation, raise taxes and monetize our debt by printing pesos putting us at risk of hyper inflation.

Where does that leave the peso? Php 60/USD is a short term target. There could be a temporary strengthening in Q4 with the seasonal influx of OFW money but the prospects after that are uncertain. Yeah, keeping some dollars around for a rainy day may be a good idea.

The Unraveling

In a post entitled So Soon, So Soon a few weeks ago I wrote about the travails of our new President so early in the Administration and the existential struggle among the many power factions for the division of spoils and command of the President’s ear. As it turns out the unraveling happened sooner than expected.

Last weekend the Executive Secretary (ES) Atty. Vic Rodriguez, the erstwhile advisor and campaign spokesperson of BBM, resigned from his office citing family reasons specifically “to witness first hand his young family grow”. After numerous years at the right hand of the now President Almighty, Atty. Rodriquez suddenly realized the importance of family and raising kids in the right values.

Vic Rodriguez is reportedly to be replaced by retired SC Chief Justice Lucas Bersamin, one of nine Justices who voted in favor of allowing ex-President Ferdinand Marcos to be buried in the Libingan ng mga Bayani. Justice Bersamin is 73 years old which brings new meaning to the term “injecting new blood” in Government. He joins a number of his peers in the geriatrically challenged Cabinet.

While accepting Atty. Vic’s resignation, in a simultaneous about face the President appointed him as his Chief of Staff sowing confusion in an already muddy affair. The move was reportedly against the advise of Presidential Legal Counsel, Juan Ponce Enrile, who if anything has the wisdom of age. It also ran counter to BBM’s announced intention to streamline his office. JPE felt the mandate of this newly created position was already covered by the Office of the Executive Secretary, the Presidential Management Staff, the Special Assistant to the President (Anton Lagdameo) and the Chief Presidential Legal Counsel (JPE). The incoming ES Bersamin presumably also wanted to know how responsibilities and authority will be shared with the first-of-its-kind PCS since they are almost identical. In the end a compromise was reached where Atty. Vic would have an office and a title but his job description would be curtailed under clear parameters defined by JPE. How this plays out in practice is another matter.

The timing of Atty. Vic’s resignation was propitious coming as it did shortly before the President flew to address the U.N. assembly in New York. This will allow for the noise to dial down before the President returns to answer questions. To his credit BBM responded quickly to mounting opposition to Atty. Vic’s stay in power. Other leaders would have dug in suggesting BBM is listening.

There are varying interpretations to the ES’ resignation but all agree on two things: One, Atty. Vic at 48 did not resign to mentor his kids to become upstanding citizens and, two, that unlike Paul he did not in 79 days have an epiphany on the road to Damascus.

The majority opinion is that Atty. Vic overplayed his hand in defining his office, in crowding out others in the appointment even of second level Government positions and in speaking by the authority of the President. In this matter he could have taken a false clue from his boss who can at times be laid back; to take matter into his hands while forgetting it takes a village to govern. As a result he offended the many power blocs around Malacanang including supporters of the First Lady, Sen. Imee, political and financial donors and the social friends of the President.

It did not help that Atty. Vic seemingly botched some of his assignments. The Senate findings on the recent sugar mess concluded Atty. Vic “was not entirely blameless” in the fiasco. There were rumors of Php 100 million changing hands for key Government positions. There was the appointment and recall of Cristopher Pastrana as General Manager of the Philippines Ports Authority after revelations of possible conflict of interest. One major religious group allegedly complained of not having its slate of recommendees accepted. Key invitations to BBM’s Inaugural were mishandled. There were unconfirmed allegations of numerous foreign bank accounts being opened with new found money. Sen. Imee ranted on national television of the “snake(s)” in the Palace and how he/they were undermining the reputation of her brother. The long knives in the Palace were unhappy with the growing influence of the ES particularly in the appointment of heads of key regulatory agencies where the bread is buttered.

Others believe Atty. Vic’s resignation is just a zarzuela where he would step down as ES but would assume the newly created position of PCS. The ES would take care of official business while the PCS would delve in the Twilight Zone where the real business of governing is done. The office of the Presidential Chief of Staff could in some ways be more powerful than that of the ES as it allows its occupant to roam freely the corridors of power unharnessed by the scrutiny of media, the public and the Legislature. The position carries a Cabinet rank but need not pass Congress’ Committee on Appointments.

It is unclear therefore whether the resignation of Atty. Rodriguez is a phyrric victory for his opponents. There are parallels in the Duterte Administration where ES Medialdea was officially the gate keeper to the President but Bong Go was the de facto presidential chief of staff getting involved where the real power lay. This parsing of duties and responsibilities is possibly more efficient but in fact will lead to confusion and deniability as fingers are pointed in a charade of “he said, she said”. We saw this in the SRA chaos where respected civil servants were thrown under the bus to save those truly at fault. Now more than ever the President will be hardpressed to attract the best and the brightest to Government. Already some recent appointees are reportedly expressing their desire to opt out as soon as the new Government settles in. There are still unfilled vacancies in key positions like Health.

It is debatable whether we have seen the last of Atty. Vic who for everything that is said has many shared experiences with the President and knows, figuratively of course, where, if any, are the bodies buried. As in all struggles power is defined not by one’s office but by the personalities of the parties, one’s closeness to the President and the political strength of those arrayed against you. There are various power blocs in Malacanang not all of whom are in concert with each other but following the dictum that the enemy of your enemy is your friend the various factions united in their opposition to Atty. Vic. Perhaps the latter can reconstitute his alliances but this seems difficult since the forces most adamantly against him are allegedly the President’s family and powerful political contributors. The PCS could still trade on the basis of his calling card but having been called out once there is less room to maneuver.

Which leads us to the question on everybody’s lips namely who will occupy the vacuum created by the exit of Atty. Vic or whether, in fact, there is any vacuum at all.

So Soon, So Soon

Hardly has the Marcos Administration taken office that it is swamped by a series of scandals some of which inherited from its predecessor and some of its own doing.

The Commission on Audit has discovered that thousands of laptops intended for teachers were overpriced by a factor of four and were below specs making them essentially useless for  applications needed in the class room. This scandal has to be laid to the watch of then DepEd Sec. Len Briones but it is up to the now DepEd Sec. Sara Duterte to sort it out. We have still to hear from her on this matter.

It was reported that certain people in Malacanang were asking for Php 100 million to have some people appointed to high office. The whistleblowers took up the issue directly with the President but no heads have rolled possibly because the accusations fell too close to home.

In the latest controversy a scheme was unearthed allegedly involving members of the Sugar Regulatory Authority (SRA) and some big sugar barons and traders to create local shortages in sugar thereby driving prices up to consumers and industrial users forcing some of them to curtail operations. This scheme adds to the continuing shenanigans in rice, chicken and pork that have contributed to the high inflation in our food bill. 

First some background. This country produces about 2 million metric tons of sugar but consumes about 2.5 million MT annually resulting in a shortage of 500,000 MT. The latter has to be covered by imports. We used to be a major exporter of sugar (as we were of rice) but this is another conversation altogether.

Historically our sugar produced has been divided into 4 classes: “A” for export to the U.S. under the Laurel Langley Act; “B” for sugar to be sold domestically; and “C” “and “D” for world exports and reserves. The latter two categories are insignificant because of the current sugar shortage. The export of “A” sugar is optional on our part.

 The SRA is responsible for classifying sugar. “A” sugar is computed at 5% of total production with the balance of 95% allocated for the domestic market as “B” sugar. “A” sugar has a price of around Php 1,200/50 kg bag while “B” sugar has traded as high as Php 4,000.

So why is the SRA allowing for the export of “A” sugar when there is a shortage in the country? One possible answer is the more we export the greater the local shortage and the greater the local shortage the greater the profit made by traders who are “allowed “ by the SRA to import sugar to cover the shortage. The landed cost of imported sugar from Thailand is significantly below the price of local sugar so importers have been able to reap profits of as high as 4 times their cost. The scheme is so lucrative even some big local sugar producers have joined the importers’ cartel. 

How big can the profits be? At 5% of production “A” sugar is roughly 100,000 MT or two million 50 kilo bags. If one can import sugar at say Php 1,100/50 bag to replace the shortage caused by the exports of “A”; and sell it locally for say Php 3,000 the profit is Php 3.8 billion (Php 3,000-1,100 x 2,000,000 bags). It is not rocket science but it works.

There is still some “A” sugar held by producers that can be reclassified to “B” to ease the current shortage but the SRA is apparently not allowing it. Maybe there is not enough incentive for it to do so.

The money trail behind our sugar shortage leads to the SRA which in addition to classifying sugar also issues the license to import it. In the latest arrangement, the SRA issued an order to import 300,000MT of sugar ostensibly upon the instruction of the President when he never did. What followed was a charade of “he said she said” between the SRA and the Exec. Secretary. The order was subsequently reduced to 150,000MT but by then the scam was exposed.

The SRA is only one of various cess pools in Government. Other are in Customs, BIR, regulatory bodies like the Energy Regulatory Commission, the Land Transportation Office, etc. At the apex of all these agencies is Malacanang or, more specifically, the people in Malacanang who get to call the shots.

Power in the Palace is a dynamic struggle between differing factions. In the Pinoy Administration there was the Samar versus the Balay faction. In Duterte’s time there was the Bong Go group versus the Pimentel side of PDP Laban versus, arguably, Sara. In the BBM Administration power is said to be divided between the Executive Secretary’s Office and the First Lady at the innermost circle; with Immediate family, the original friends of BBM, key members of the Legislature and the big political contributors like certain businessmen and the INC; at the next. The latter is reportedly unhappy about being unable to place its full slate of candidates in key agencies. The rule of thumb in politics is that power is correlated with how much alone time one has with the President. By this measure the Executive Secretary probably spends the most waking time with the President, the First Lady, I imagine, the most sleeping time.

Power in Malacanang is like an iceberg: Some of it is visible above the water but most of it under unseen by the naked eye. Thus power is wielded through one’s office but, more extensively, by the people one is able to appoint to head the various “money making centers” in Government. The monetary value of the latter varies with each agency. In the case of one infrastructure office the top position was said to be worth Php 100 million. Can you imagine what is the value of being able to appoint the heads of Customs, BIR or the ERC?

The appointment of key agency positions is not restricted to the top posts. It also applies to under secretaries who deal with the nitty gritty of governance and have the advantage of not having to pass the Committee on Appointments.

The protagonists in this political Game of Thrones operate outside the formal chain of command. By and large the President has appointed a good Cabinet. However as I wrote two months ago and as we are seeing now, these men and women are being by-passed in many of the key decisions. This playbook is reminiscent of the first Marcos Administration when unbeknownst to Cesar Virata & Co. cronies were making end runs around them. This is not to say that BBM will do likewise but as we witnessed in the SRA  scandal when Malacanang had to reverse himself on the importation of sugar; the job of President is just too vast for him to know and see everything. He has to rely on his judgement of people immediately surrounding him and right now that judgement is in question.

The new Administration will have its teething problems as the various power players vie to divide the spoils. BBM must ensure that no single faction gets to irreversibly imbed itself in the decision making and implementation of policy. He must divide and conquer so there is checks and balance. He must ensure that he holds the reins so that power emanates from him and not by those claiming to act “by the Authority of the President”.

As it is so soon, so soon is the infighting taking place in the Palace we must wonder if to inflation, poverty, unemployment, crime, climate change, and our trillion pesos in debt; we must now add a potentially dysfunctional Government. 

There Are Truths, There Are Lies And There Are Statistics

The second quarter numbers are out: The economy grew by 7.4%. This, we will be proudly told, is the second highest in the region even though (a) it is a comparison with last year’s dismal numbers when we were the worst performer (b) it is below what analysts expected or were led to expect and (c) it is below Q1’s figure of over 8% i.e. the economy actually contracted in Q2, decelerating so early in the recovery cycle. 

The major drivers of the economy were consumption as people went “revenge” shopping and construction as projects held up by COVID were completed. Agriculture, a priority sector, declined by 0.6%. Inflation continued its climb to 6.4%. Our international reserves dropped by some 10%. The peso fell by 7% since the start of the year and by 11% since a year ago. Our public debt grew to a record Php 13 trillion. There are now 3 million officially unemployed, at least that figure underemployed, 20 million are living below the poverty line and 42% of those polled believe “they are poor”. 

This is the state of the nation that we are told is fine. Is there something I am missing?

One of the most important skills of economic management is how and what to communicate to the markets. The tone of the messaging provides investors and businessmen with forward guidance which they use in deciding whether to invest, hire people, buy more machinery and build inventory. 

The President’s SONA laid out the Administration’s Six Year Economic Plan which in a nutshell is more of everything we like – growth, jobs, technology, agriculture, education, manufacturing, health, fiscal prudence, fully funded pensions – and less of everything we don’t like taxes. The SONA did not say what the final bill would be but by my count  is a deficit of some Php 2 trillion a year. This pace would double our public debt by 2028.

Our economic officials assure us if we can just grow and grow we will be able to work down our debt. This “growth surplus” theory goes something like this: In the last 20 years our fiscal deficits have averaged around 5% of GDP and Government revenues around 12% of GDP. So if for every Php 100 of additional GDP we can collect Php 12 in taxes this more than covers the Php 5 in deficit. The difference of Php 7 can then go to pay down our debt. The equation may work but the facts don’t validate it: Despite a nominal annual average growth rate of around 9%, except for 2003 when there was a rash of privatizations, our public debt has grown every year from Php 2.2 trillion in 2000 to Php 13 trillion this year. This tells me either (a) our deficits are under reported (b) our tax revenues are over reported or (c) we have lost the Php 7 surplus through leakages like corruption or funny accounting. The narrative that we can grow our way out of debt has not proven to be true so for us to be told otherwise is either whistling in the dark or an aspirational fantasy.

Economic managers will invariably talk up an economy. They will want to assure investors they are in control which protects one’s sovereign credit rating, comforts creditors, boosts business confidence and keeps their job. Our new Government is also mindful not to be critical of the previous Administration. After all Duterte’s daughter is BBM’s VP, DOF Sec. Ben Diokno was a protege of Sec. Dominguez, BSP Governor Medalla an associate of Diokno. It is all very cozy. NEDA Sec. Arni Balisacan has no such ties so he is a little more open: He believes “we face obstacles but these are surmountable” which in public parlance is the equivalent of a wink and a nod. ( Btw Balisacan has seemingly assumed the role of Economic Spokesman which reflects his closeness to the President relative to his peers. He was one of BBM’s first appointees.)

Economic messaging can be tricky, like cheating on your wife a fine balance between holding her hand and not quite telling the truth. Too much of one and not enough of the other can spell trouble as we see in the U.S. Federal Reserve Chairman Powell proclaimed last year that U.S. inflation was “transitory”. This encouraged the U.S. Government to blow out its deficit by over $3 trillion and send prices sky rocketing. He has now to eat his words and defend an inflation of 9%, the highest in 40 years, and a 20% drop in the stock market. Worse, investors are now taking his words with skepticism. 

Powell admits he was wrong in his early assessment and the Fed now needs to aggressively reverse itself to bring down prices. Last week the Fed raised its fund rate by 75 basis points after a similar record raise the previous month. However, rather than tank, the U.S. stock market spiked by 7% in the 3 consecutive days following the announcement. This was counter intuitive since markets are supposed to fall when interest fates rise. The rally also further fuels inflation through the wealth effect making the Fed’s war on prices that much harder. It appears investors are skirting the Fed narrative. Partly as a result, the Fed announced it is no longer providing forward guidance.

The lesson is public officials whether in the U.S., here or elsewhere cannot talk like second car salesmen. Then NEDA Sec. Karl Chua tried it once when he proclaimed in the spring of 2020 that COVID was a “hiccup” and was never really taken seriously after that.

Economic guidance is crucial to economic management. Monetary and fiscal tools are effective only when coupled with transparent, honest and consistent messaging on the true state of affairs. The key is trust and confidence. Once the latter is lost, once markets realize they are being manipulated they will no longer respond as desired to official guidance. Businessmen do not want to be talked to like 5th graders. They see the realities on the ground. So don’t tell them that inflation is manageable when companies are witnessing 30% rises in their raw materials, when consumers are trading down to more affordable food products, when gas is up over 40% and grocery bills over 10%.

To be fair our economic managers are relying on numbers from the Philippine Statistics Authority which are backward looking or not reflective of the true consumer basket. As a result they are invariably behind the curve. Four months ago the BSP proudly announced that local interest rates need not follow the U.S. path because our inflation was less than half that of the U.S. Well our inflation rose from under 4% to over 6% two months later forcing the BSP to ratchet up interest rates but by then the horse had fled the barn. In that period the peso plummeted 7% which has further fueled inflation. Whether COVID or economic policy our officials are consistently playing catch-up. 

Our economic managers need a broader view of the landscape than a couple of data points from the PSA. They should look at inflationary expectations which are forward looking. They should talk to businessmen about their costs, do the household groceries once in a while. Backward looking data, arguably incorrect numbers and a fear of spooking the populace with honest assessments has resulted in pronouncements that are seemingly spun leading to confusion, doubt, false hopes and disenchantment. Most countries openly warn of the difficult journey ahead. We do the opposite. Whether “Php 20/kg rice” or no need for taxes on an “easily manageable” public debt our officials sell us on a dream that is not there. The Dept. of Agriculture has admitted the former is not possible, the outgoing DOF that new taxes are needed.

The most powerful tool of economic managers is neither monetary nor fiscal but trust and credibility. Once you lose these, once the genie is let out of the bottle it is very hard to get it back in.

As I said economic messaging can be like cheating on your wife. Just don’t get caught.

SONA 2022: The Numbers Do Not Add Up But Never Mind

“Hope Is Not A Strategy” – Larry Summers, Ex-U.S. Treasury Secretary

It is told one never remembers what was said in a speech only how one felt when the speaker said it. BBM’s SONA was a little bit like that, a sense of elation when he spoke that became less frothy when one examined what he said or, in this case, not say but more on this later.

BBM’s SONA was very respectable. He checked most of the boxes – the economy, education, the environment, agriculture, technology, OFWs, infrastructure – plus some surprising ones – ROTC – with 19 new laws to be passed. 

The speech was part ho-hum as he rattled through the economic numbers – growth, inflation, debt/GDP, deficits/GDP, etc – and part rousing in BBM’s quiet way as he moved into areas like agriculture which he clearly has a soft spot for. Exec. Sec. Vic Rodriguez disclosed the President personally penned the entire SONA even if the first quarter of the address had NEDA technocracy written all over it.

SONAs are part report card on where we are and where we are going; and part expressions of hope. As the first SONA of BBM’s term this one was actually an assessment of the Duterte Administration more than it was on his since he has only been 25 days in office. BBM was kind enough not to dump on Duterte for what many believe is the mess he has inherited lauding him instead for the oh so many infrastructure projects initiated.

SONAs are also invariably used as a bully pulpit to excoriate your enemies and as a rallying cry for the masses. Pres. Duterte was especially fond of saying how the oligarchs were (not incorrectly) raping the nation and the Communists (not correctly) taking over Government. BBM was more businesslike. There were few applaudable moments, hyperboles, high prose or references to hanging businessmen from lamp posts; but boring sometimes is good.

BBM’s SONA was almost entirely about the economy. Our GDP is now around Php 20 trillion. The economy is projected to grow annually by 6.5-8% in real terms and inflation to be contained to around 5% which means that in nominal terms the economy will grow by 11.5%-13% annually compounded over the next 6 years. The debt/GDP ratio and deficit to GDP ratio will be kept at below 60% and to 3% respectively by the end of his Administration. He will spend 5-6% of GDP annually on infrastructure, presumably close to this figure for education since the latter is constitutionally mandated to have the highest budget allocation, invest heavily in agriculture and digitize Government. 

These are wonderful goals. The only problem is the numbers do not add up but his economic team did not tell him that.

The 2023 Budget is around Php 5 trillion. I estimate about 80% of this is already allocated for recurring revenues like salaries, interest costs and multi-year commitments leaving only about Php 1 trillion for new spending. Let us go through what the SONA promised: 

  1. An annual infra spend of 5% of GDP equals Php 1 trillion. Even if say 50% of this was shared with the private sector under the PPP the Government’s share is Php 500 billion per annum. 
  1. Interest costs are now about Php 400 billion but rates are expected to rise by some 200 basis points. I estimate this would add Php 260 billion to our interest charges. This excludes the impact of our peso devaluation on our dollar denominated debt of around USD 80 billion.
  1. Based on the cost of digitizing a large company I estimate the expense to comprehensively digitize the economy would be some Php 300 billion over 3 years or Php 100 billion per annum, much of this front ended. The National ID program has cost us Php 31 billion and it still is not completed. Bringing our management information system to standard means digitizing the Government’s entire data base, upgrading our software to a common platform that is interoperable across all agencies, hiring outside consultants and training civil servants; all of which is expensive.
  1. The relaunch of agriculture will require water irrigation, farm-to-road markets, subsidies to farmers, etc. which Government will have to undertake without PPP since these are not the purview of the private sector.

5. Upgrading education could cost another Php 100 billion.

6. A GSIS actuarial study concluded that the Government has an unfunded liability for military pensions of Php 850 billion annually for the next 20 years.

7. Inflation of 5% p.a. could add more than Php 100 billion to existing recurring costs. 

So this is the incremental annual bill based on the SONA: Infra Php 500B, interest charges Php 260B; digital transformation Php 100B; agriculture say another Php 50B; military pensions Php 850B; and inflation of Php 100B or a grand total of Php 1,860B. This will more than double our current budget deficit of around Php 1,400B raising our deficit/GDP to 16% and our debt/GDP to 74% versus the target of 3% and under 60% respectively. At this pace we would double our public debt by 2028 unless we raised taxes and/or sold our patrimony. We do not have limited fiscal space, we have standing room only fiscal space.

The economic managers will say this is not so, that with nominal growth in GDP of double digits our tax collections will follow suit thereby narrowing our deficits. This has not happened in the last 20 years. In this century we have grown on average by about 10% in nominal terms yet our deficits and public debt have steadily risen, not fallen. Our tax base is only some 11-14% of GDP so it will never be able to catch up with the deficits.

We can mitigate some of these numbers by “right sizing” the bureaucracy but the impact is small. The DBM estimates a 5% reduction in staffing will save only Php 15 billion. Anything larger could trigger a blowback from our civil service.

Interest rates will eventually come down but not for another 12 months.

Inflation could recede but already we are using a Government estimate of 5% versus the present rate of 6%.

The good news is what with supply chain constraints, project vetting, PPP negotiations, Local Government delays and Government’s absorptive capacity, we will not be able to spend Php 500 billion in infra projects annually. As it is there are Php 5 trillion in stranded infra projects. The upgrade of NAIA is going on its 20th anniversary of discussions.

The above analysis is a back-of-the-envelope computation that clearly could be refined (hey, I am just an outsider googling data). Some of the incremental numbers may already be imbedded in the current Budget so there is possible double counting. Yet the orders of magnitude are such that it leaves much for skepticism. Note we have not included additional spends for health, the environment and social welfare which the President identified as priorities. Nor have we inputted the cost of corruption which I easily estimate at 10% of Budget.

Which leads us to the elephant in the room, the one topic on everybody’s mind that was glaringly absent from the SONA: Corruption. Was the matter not core enough or the linen too dirty to be washed in public and before the diplomatic corps? The business community was so agog with the economic promises even they forgot to raise the issue. The absence of even a foot note on corruption brought down what was otherwise an A- SONA to a B.

To sum up the SONA numbers do not seem to add up but never mind. We felt good for a while. The new Administration is promising us hope even if hope is not a strategy. The President concluded his SONA by saying “the state of the nation is sound” but I suppose he had to say that. We trust he does not regret his words when he checks his inbox tomorrow morning.