price stabilization measures and its effects on - Philippine Institute ...

udget subsidy needed to implement the lower domestic <strong>price</strong> but they gain at the expense of theproducers who must pay an implicit tax of the same amount per unit. A major effect of such apolicy is to thus alter income distribution <strong>and</strong> resource allocation patterns. Efficiency losses orwelfare losses arise due to distortions in the allocation of resources from their most efficient usesin production or consumption. To compound the problem, subsidies are difficult to administerfor political <strong>and</strong> administrative reasons. The subsidies are channeled to individuals through agovernment bureaucracy which creates <strong>its</strong> own inefficiencies <strong>and</strong> disincentives to exp<strong>and</strong> output(Timmer, 1986). In short, <strong>price</strong> support <strong>and</strong> input subsidy programs are expensive programs forthe government to pursue <strong>and</strong> thereby are not sustainable. Hence, this paper attempts to suggestsome non-<strong>price</strong> <strong>measures</strong> to control inflation <strong>and</strong> achieve <strong>price</strong> stability.The export sector st<strong>and</strong>s to greatly benefit from a regime of stable <strong>price</strong>s. One of thefactors affecting the competitiveness of Philippine exports has been increasing factor costs orinput costs. Unpredictability in <strong>price</strong>s of inputs has resulted in less flexibility on the part ofexporters who are unable to efficiently plan ahead. Further eroding the competitiveness of ourexports is the strong competition from cheap producers like China <strong>and</strong> Vietnam.CONCEPT OF INFLATION AND RELATED ISSUESInflation refers to the economic condition of continuously rising general level of <strong>price</strong>s ofgoods <strong>and</strong> services, resulting in a loss of the purchasing power of money. The inflation rate isone of the common indicators derived from the Consumer Price Index (CPI) which is a measureof the average retail <strong>price</strong> of a st<strong>and</strong>ard “basket” of goods <strong>and</strong> services consumed by a typicalFilipino family. The composition of such st<strong>and</strong>ard basket is determined by a Family Income <strong>and</strong>Expenditure Survey (FIES) periodically conducted by the National Statistics Office (NSO). Inbrief, the Philippine CPI basket is accounted for by food items (58.5 percent), housing <strong>and</strong>repairs (13.3 percent), clothing (4.4 percent), services (10.9 percent), fuel, light <strong>and</strong> water (5.4percent) <strong>and</strong> miscellaneous items (7.6 percent). Because food accounts for more than half ofthe index, variations in agricultural output, either due to seasonal factors or low agriculturalproductivity have made the inflation rate more volatile. Inefficiencies in the agricultural sectorhave led to a system chain reaction in the economy. These inefficiencies have led to higherinflation, dem<strong>and</strong> for higher wages, <strong>and</strong> consequently, the institution of food policies.Several studies have raised the question as to the suitability of the CPI as a measure ofinflation especially for monetary policy. Crawford, et. al. (1997), for example, considered twoother <strong>measures</strong> of aggregate <strong>price</strong>s: the implicit gross domestic product (GDP) deflator, <strong>and</strong> unitlabor costs. There are also issues as to how the underlying or “core” inflation should bemeasured <strong>and</strong> the size of the bias in CPI inflation. The core inflation index excludes either foodor energy products or both in order to reduce volatility in inflation figures. If food is removedfrom the commodity basket, more moderate declines or increases in the <strong>price</strong>s of goods <strong>and</strong>services than what the official inflation data shows will be recorded.2

Types of InflationThere are essentially three types of inflation: dem<strong>and</strong> pull, cost push, <strong>and</strong> structuralinflation. Dem<strong>and</strong> pull inflation is caused by higher aggregate dem<strong>and</strong> compared to availablesupply or aggregate dem<strong>and</strong> exceeding full employment output. Cost push inflation ischaracterized by the rise in <strong>price</strong>s resulting from increases in the cost of production withoutcorresponding increases in output. Examples of this would be increases not matched byincreased productivity of labor, hikes in international oil <strong>price</strong>s, higher cost of capital, increasesin <strong>price</strong>s of raw materials, <strong>and</strong> hikes in rental rates. Structural inflation occurs when there aredeficiencies in certain conditions in the economy such as a backward agricultural sector that isunable to respond to the people’s increased dem<strong>and</strong> for food, inefficient distribution <strong>and</strong> storagefacilities leading to artificial shortages of goods, <strong>and</strong> production of goods controlled by somepeople.There are evidences to show that past Philippine inflationary trends have been influencedby a combination of the three causes, <strong>and</strong> these are often times interrelated to one another. Whenseveral types of inflation occur simultaneously, it may be necessary to adopt a set of <strong>measures</strong> toaddress the underlying forces behind the <strong>price</strong> changes. There are trade-offs to reckon with suchas the observed tendency of <strong>price</strong>s <strong>and</strong> unemployment to move in opposite directions. Slowingthe rate of inflation may mean an increase in the level of unemployment, lower levels of output,<strong>and</strong> a possible recession in the economy.Cost <strong>and</strong> Benef<strong>its</strong> of Low Inflation <strong>and</strong> Price StabilityThere have been studies on the gains from <strong>price</strong> stability. For example, Feldstein (1997)has shown that inflation exacerbates the tax distortions that would exist even with <strong>price</strong> stability.The annual deadweight loss of a two percent inflation rate is a large one percent of GDP. Sincethe real gain from shifting to <strong>price</strong> stability grows in perpetuity at the rate of growth of GDP, <strong>its</strong>present value is a substantial multiple of this annual gain. Discounting the annual gains at therate that investors require for risky equity investments implies a present value equal to more than35 percent of the initial level of GDP. Since the estimated cost of shifting from two percentinflation to <strong>price</strong> stability is about five percent of GDP, the gain substantially outweighs the costof transition (Feldstein, 1997).Available evidence suggests that the benef<strong>its</strong> of <strong>price</strong> stability are many <strong>and</strong> large whilethe costs of getting there are transitory <strong>and</strong> small by comparison. Moreover, progress towards<strong>price</strong> stability is easier when wages <strong>and</strong> <strong>price</strong>s are flexible <strong>and</strong> when the monetary authority hascredibility (Selody, 1997).Inflation <strong>and</strong> GrowthThere is a large <strong>and</strong> growing body of empirical literature on the relationship betweeninflation <strong>and</strong> long-run economic growth. Despite this effort, robust estimates of the <strong>effects</strong> ofinflation on growth remain elusive. While most studies showed a negative relationship, therange of estimates was large, <strong>and</strong> many studies found that the relationship was not statisticallysignificant (Ambler <strong>and</strong> Cardia, 1997). Using a general equilibrium model, they showed that3

<strong>price</strong>s of imported inputs. A larger group of structuralists comprising the second group, however,views inflation arising from the unbalanced growth of different sectors <strong>and</strong> productionbottlenecks.The first type of production bottleneck stems from a slow growth of the export sector,usually primary exports, which leads to export earnings being inadequate to support the importrequirements of industries. Since export earnings fall short of the import needs, this leads to aslow growth of aggregate supply which means a persistent excess dem<strong>and</strong> condition exerting acontinuous upward pressure on <strong>price</strong>s. This phenomenon also contributes to the unevenrelationship between exports <strong>and</strong> <strong>price</strong>s; an increase in export earnings may have an inflationaryeffect by increasing aggregate dem<strong>and</strong> but a fall in export earnings will exert or have no effect atall on <strong>price</strong>s due to the structuralist argument <strong>and</strong> because <strong>price</strong>s are sticky downwards.A constant shortage of food is the second major bottleneck. A persistent shortage of fooddue to the backwardness of the sector would provide an upward push on the general <strong>price</strong> level.Meanwhile, the downward rigidity of <strong>price</strong>s in the non-food sector which may be due to themonopolistic or oligopolistic structure of the sector or strong trade unions would also cause thegeneral level of <strong>price</strong>s to rise.Other major bottlenecks may be traced to structural features of the economy such aslagged development of transportation, communication <strong>and</strong> other infrastructure, graft, corruption<strong>and</strong> other types of bureaucratic delays as well as insufficient capital formation. These bottlenecksdiminish the competitiveness of industries. Figure 1 shows the structuralist view of Philippineinflation.Several studies have dealt with the welfare <strong>effects</strong> of inflation as well as the benef<strong>its</strong> of<strong>price</strong> stability. When the present value of the benef<strong>its</strong> of low inflation is compared with thepresent value of the cost of achieving (<strong>and</strong> maintaining) low inflation, the conclusion arrived at isthat the benef<strong>its</strong> of reducing inflation, which stem from both the reduced cost of holding moneybalances <strong>and</strong> the elimination of distortions in the tax system, outweigh the costs.The immediate impact of inflation is a decline in the purchasing power or in the amountof goods <strong>and</strong> services any given amount of money can buy. Thus, households with a fixedincome can only buy a smaller amount of goods <strong>and</strong> services. Unfortunately, these usually tendto be low- income households while higher-income households have more flexibility toneutralize inflation by investing in assets that hold their value against inflation.With the declining value of money, people would be more inclined to spend than save,anticipating that their money can buy even less in the future. Therefore, inflation has adverse<strong>effects</strong> on savings <strong>and</strong> investment.5

Figure 1. Structuralist View of Philippine InflationCauses of Inflation Policy Measures to ControlInflationCost-PushAdvocatesUnbalancedStructural Growth<strong>and</strong> ProductionBottleneckshigh wageshigh power rateshigh <strong>price</strong>s ofimported inputsslow growth of primary exportsconstant shortage of foodother structural features such aslagged development oftransportation/communication,insufficient capital formationInflationdevelopment of the export sectorliberalize food trade <strong>and</strong> fooddiversificationincrease investment in infrastructure,research <strong>and</strong> developmentdevelopment of the financial sector6

Inflation can also erode the profitability of producers <strong>and</strong> the external competitiveness ofdomestic products if it leads to higher production costs such as wage increases, higher interestrate <strong>and</strong> currency depreciation. Price stability is critical for producers <strong>and</strong> exporters alikebecause high <strong>and</strong> volatile <strong>price</strong>s of inputs reduce the flexibility of producers to efficiently planahead. Increases in wage rates which are unmatched by increases in labor productivityeffectively result in higher production costs for the firm. This is especially important for firms orindustries which are labor intensive like the fruit-processing industry. The industry employsmanual labor for sorting, cooking, bottling <strong>and</strong> packing <strong>its</strong> products. The export industries alsoneed stable <strong>price</strong>s for their inputs to be able to respond quickly to new trends in market dem<strong>and</strong>.Otherwise, when firms are unable to do so, competition from cheap producers like China <strong>and</strong>Vietnam will capture the market.Most export industries also suffer from weak backward linkages. The garments industry,which used to be the banner export industry of the country, is forced to import more than half of<strong>its</strong> input requirements leading to high materials costs <strong>and</strong> longer turnaround time. This is alsotrue for the electronics industry which sources a great portion of <strong>its</strong> materials from abroad. Theseindustries require stable <strong>price</strong>s to maintain their presence in the global market. These industriesalso need to be able to compete in the higher end segment of their market; <strong>price</strong> stability willhelp these industries to do so. A period of stable <strong>price</strong>s will give the export industries time tofocus their strategies in improving <strong>and</strong> maintaining their global competitiveness without havingto worry about how much production costs will be because <strong>price</strong>s are rising unpredictably.Empirical Studies on the Causes of Price Instability in the PhilippinesA review of the factors affecting <strong>price</strong> stability in the Philippines will enable policymakers to implement appropriate policies to maintain <strong>price</strong> changes at a manageable level.Lim (1996) showed that cost-push <strong>and</strong> dem<strong>and</strong>-pull factors are important factors in thedetermination of the <strong>price</strong> level. The <strong>price</strong> of imported goods has the highest elasticity, followedby wages <strong>and</strong> money supply.An earlier study of Bautista (1983) showed that a large part of inflation for the period1965-1982 could be attributed to world <strong>price</strong> increases <strong>and</strong> the depreciation of the peso. Hepointed out also that the increase in oil <strong>price</strong>s put more upward pressure on inflation. However,his study did not find money supply <strong>and</strong> wages to significantly affect inflation.Another study of Lim (1985) indicated that the increase in inflation was caused by therise in interest rates which increased the cost of borrowing for working capital. This wassupported by his empirical results that indicated a positive relationship between interest rates <strong>and</strong>inflation. Meanwhile, Bautista (1991) showed that the forecast error variance of inflation due tochanges in the exchange rate was higher than that of money supply growth. However, theempirical result of his study did not show that money supply growth fuelled by fiscal defic<strong>its</strong>,was unimportant. Important items in production cost consist of wages, salaries, power rates, <strong>and</strong>energy <strong>price</strong>s. Structuralists who advocate a cost-push driven inflation have pointed out thatinflationary pressures are generated by increases in nominal wage rates in excess of laborproductivity. As <strong>price</strong>s of food commodity rise, putting pressure on wages to increase <strong>and</strong>7

engendering further <strong>price</strong> increases in the other sectors of the economy, a vicious cycle willoccur. This upsurge in the cost of living will push wages to increase independently ofproductivity movements.Wage rates in Manila are pegged at $7/day while in Bangkok, labor rates are at$5.75/day. These have greatly affected labor-intensive industries utilizing low-skilled labor likethe fruit-processing, textile, <strong>and</strong> local garments industries.Power rates <strong>and</strong> energy <strong>price</strong>s tend to influence the <strong>price</strong>s of output that causeinflationary pressures in the economy. The Philippines has the highest retail <strong>price</strong> of electricityin the ASEAN region although <strong>its</strong> electrification level is comparable with neighbors of similarlevel of development (NEDA, 1998). Electricity rates in the country in 1997 were at$0.1128/kwh while in Singapore, electricity costs were just $0.0865/kwh (Payumo, 1998).Bernardo (1999) asserted that privatization <strong>and</strong> increased competition particularly at thegeneration end could reduce power costs from the current average cost of the National PowerCorporation of P2.60/kwh to P1.60/kwh, or as much as 38 percent.TRENDS IN INFLATION IN THE PHILIPPINESThe annual inflation rate in the Philippines has almost always been positive over the pastfour decades (Table 1). Not only has CPI grown monotonically but <strong>its</strong> growth has been ratherrapid, compared to many developed <strong>and</strong> developing countries. In certain episodes of the postwareconomic history, inflation was double digit. These are much lower, however, than thehyperinflation type suffered by countries like Argentina, Mexico, Russia, <strong>and</strong> recently Indonesia.Since 1992, the average annual inflation rate has been kept at a single digit. A rate of 8.9percent was posted in 1992, a marked deceleration from the 18.7 percent in the previous year. In1993, inflation decelerated further to 7.6 percent. Inflation was higher at 9.0 percent in1994, butstill within the 9.5 percent target inflation in the economic <strong>and</strong> financial program supported bythe International Monetary Fund (IMF).8

Table 1. Average rates of inflation, selected countries, 1960-1996.Country 1960-69 1970-79 1980-89 1990-90 1960-96ArgentinaAustraliaBangladeshDominican RepublicIndiaIndonesiaJapanMalaysiaMyanmarPakistanPeruPhilippinesSingaporeThail<strong>and</strong>United States22.422.314.491.846.50232.605.550.834.133.3016.674.621.182.562.42127.939.8319.609.207.5416.929.095.5010.8611.7626.8414.645.918.007.10570.508.4111.2620.879.129.632.533.6510.097.27481.1615.052.795.825.55361.273.214.5219.0410.068.621.443.9724.1710.771151.3910.702.525.123.42269.866.2710.5712.528.2167.204.903.5211.558.21369.1611.483.205.474.78Source of Basic Data: World Development Indicators, The World Bank, 1998Based on CPI (1987=100)Several cost-push factors tended to raise inflationary pressures (Tables 2 <strong>and</strong> 3). Theseincluded temporary agricultural shortages spawned by the series of typhoons in December 1993,phased increases in minimum wages in December 1993 <strong>and</strong> April 1994, some speculations aboutthe temporary fuel <strong>price</strong> increases early in the year <strong>and</strong> the impending implementation of theexp<strong>and</strong>ed value-added tax (EVAT). A depreciating peso <strong>and</strong> the uptrend in interest rates <strong>and</strong> inmoney supply growth also partly pushed <strong>price</strong>s upward during the period.Prices during the first half of 1995 were generally stable despite some unanticipatedexternal shocks <strong>and</strong> the rising domestic liquidity in the early part of the year. However, this trendwas reversed in the last four months of the year as the rice shortage pushed inflation to doubledigitlevels. Supply-side factors such as the dry spell which significantly affected rice <strong>and</strong> cornproduction, the resulting rice shortage which was aggravated by hoarding <strong>and</strong> delayed riceimportation, <strong>and</strong> the foot-<strong>and</strong>-mouth disease in hogs contributed to the increase in <strong>price</strong>s. For1995, inflation averaged 8.0 percent compared with the year-ago level of 9.0 percent <strong>and</strong> thewhole year target of 6.5-7.5 percent. For the first quarter of 1996, inflation remained doubledigitat an average of 11.6 percent. The lingering effect of the rice shortage, the implementationof the EVAT, the increase in the <strong>price</strong>s of oil products, <strong>and</strong> their combined influence on higher<strong>price</strong> expectations contributed significantly to this relatively high <strong>price</strong> regime.The recent financial crises resulted in a higher inflation rate in 1997 <strong>and</strong> 1998, but werecontained within the single digit target level. In 1998, inflation rose to 9.7 percent (1994=100)due mainly to weather-related disturbances <strong>and</strong> lagged <strong>effects</strong> of the sharply depreciated peso9

<strong>and</strong> high interest rates. However, the inflation rate was below the government’s target of 9.25-9.75 percent.In the Philippine context at least, inflation is still regarded as a threat to macroeconomicstability. After being maintained at a single digit level for the past four years, 1995–1998,inflation reached double digit in the first quarter of 1999. The Philippines remains to be one ofthe high inflation countries in Asia, although the average inflation rate of 8.2 percent from 1995to 1998 was better compared to other Asian countries affected by the financial crisis. Incomparison to other Asian countries, <strong>price</strong> movements in the Philippines used to acceleratefaster. In 1992, the inflation rates of Malaysia, Taiwan, Thail<strong>and</strong>, <strong>and</strong> Singapore were recordedat 4.7 percent, 4.5 percent, 4.2 percent <strong>and</strong> 2.3 percent, respectively, as compared to thePhilippines' 8.9 percent. Nevertheless, the inflation differential has narrowed down as thecountry's inflation has moved more closely to those of said Asian countries.Nominal interest rates for both borrowing <strong>and</strong> lending instruments of banks slightlyincreased from 1992 to 1998. However, the growth in domestic interest rate is decreasing whichcould be the result of the efforts of the government to bring down the bank’s cost of borrowing.In addition, the downward trend of the nominal interest rate could have also been influenced bythe BSP’s policy of reducing the reserve requirements of banks that resulted in the reduction ofthe intermediation cost. Furthermore, the moral suasion adopted by the BSP over banks tooperate in a manner that will contribute to the attainment of the monetary goal of the governmentbut consistent with the profit maximization of the banks also helped in the reduction of theinterest rate.Table 2. Consumer Price Index (CPI), Philippines, 1995-1998ITEMS 1995 1996 1997 1998Food <strong>and</strong> Beverages 109.0 120.4 124.5 135.8Clothing 106.2 112.0 119.3 128.6Housing <strong>and</strong> Repair 111.1 122.9 135.7 151.4Fuel, Light <strong>and</strong> Water 103.1 109.4 119.4 126.4Services 106.4 115.7 129.6 148.1Miscellaneous 102.8 102.7 106.4 115.2All 108.0 117.8 124.8 136.9Source: Selected Philippine Economic Indicator, BSP, April 1999.10

Table 3. Contribution to inflation by commodity, Philippines, 1995-1998ITEMS 1995 1996 1997 1998Food <strong>and</strong> Beverages 5.00 5.80 1.90 4.85Clothing 0.20 0.20 0.20 0.29Housing <strong>and</strong> Repair 1.60 1.60 1.50 1.70Fuel, Light <strong>and</strong> Water 0.20 0.30 0.50 0.34Services 0.80 1.10 1.50 1.80Miscellaneous 0.20 0.00 0.30 0.70All 8.00 9.10 5.90 9.70Source: Selected Philippine Economic Indicator, BSP, April 1999.PERFORMANCE OF THE EXPORT SECTORExports continued to grow from U.S. $ 20,543 million in 1996 to U.S. $ 29,496 million in1998 (Table 4). However the rate of growth of export decreased from 22.81 percent in 1996-97to 16.92 percent in 1997-98. Imports on the other h<strong>and</strong>, experienced a downward trend fromU.S. $ 36,355 million in 1996 to U.S. $ 29,524 million in 1998. With the positive growth ofexports of 16.92 percent <strong>and</strong> a negative growth of 18.79 percent in imports <strong>and</strong> because of thepeso devaluation <strong>and</strong> economic slowdown, the trade balance deficit declined significantly toabout U.S. $ 28 million in 1998 (compared to U.S. $ 11.13 billion trade deficit in 1997).Tables 4 <strong>and</strong> 5 show the performance of the export sector. In 1998, the total value ofPhilippine merch<strong>and</strong>ise export amounted to US $ 29.496 million or about 43 percent of GNP atcurrent <strong>price</strong>s. Total exports have shown an impressive growth in the last five years. In 1998,total exports grew by about 17 percent, although it declined slightly compared to the 1996-97growth rate of about 23 percent. However, deeper analysis shows that this export success islargely illusory (Table 5).The structure of the export sector is lopsided. It is dominated by only two manufacturingindustries: the electronics or semi-conductor <strong>and</strong> the garment industries. In 1998, the electronics<strong>and</strong> garment industries contributed about 58 percent <strong>and</strong> 8 percent of the total export receipts,respectively. Thus, the two industries contributed more that 65 percent of the total export value.This structure has been existing since the 1980’s. It is interesting to note, however, that the twoindustries have very limited contribution to the domestic economy because substantial amountsof their input requirements are imported. Take the case of the electronic industry; the countrydoes not have the technology to supply <strong>its</strong> input requirements. It sources from 75 to 90 percent of<strong>its</strong> materials from abroad. The garment industry, on the other h<strong>and</strong>, has to import raw fabric to becompetitive in the world market because of the inefficiency of the local textile industry. Thus,11

Table 4. Philippine exports by major commodity, 1990-1998 (In million U.S. $)Commodity Group 1990 1991 1992 1993 1994 1995 1996 1997 1998Coconut Products 496 439 633 494 607 974 730 835 831Sugar <strong>and</strong> Sugar Products 133 136 110 139 77 74 139 99 100Fru<strong>its</strong> <strong>and</strong> Vegetables 326 393 371 439 429 458 486 459 446Other Agri-Based Products 431 504 432 476 530 575 506 506 465Forest Products 94 73 57 45 26 38 42 45 24Mineral Products 442 388 416 422 510 552 772 764 591Petroleum Products 155 175 150 136 132 171 273 157 129Manufacturers 5995 6633 7525 9031 10917 14224 17106 21488 25866Elec. & Elec. Eqpt./Parts & Telecom 1964 2293 2753 3551 4984 7413 9990 13052 17156Garments 1776 1861 2140 2272 2375 2570 2423 2349 2356Special Transactions 19 17 37 38 74 108 157 263 311Re-exports 95 82 98 165 181 273 332 512 733TOTAL EXPORTS 8186 8840 9829 11375 13483 17447 20543 25228 29496Source: Foreign Trade Division, NSOYear12

Table 5. Philippine exports by major commodity, 1990-1998 (In percent change).YearCommodity Group 1991 1992 1993 1994 1995 1996 1997 1998Coconut Products (11.49) 44.19 (21.96) 22.87 60.46 (25.05) 14.38 (0.48)Sugar <strong>and</strong> Sugar Products 2.26 (19.12) 17.27 (40.31) (3.90) 87.84 (28.78) 1.01Fruit <strong>and</strong> Vegetables 20.55 (5.60) 18.33 (2.28) 6.76 6.11 (5.56) (2.83)Other Agri-Based Products 16.94 (14.29) 10.19 11.34 8.49 (12.00) 0.00 (8.10)Forest Products (22.34) (21.92) (21.05) (42.22) 46.15 10.53 7.14 (46.67)Mineral Products (12.22) 7.22 1.44 20.85 8.24 39.86 (1.04) (22.64)Petroleum Products 12.90 (14.29) (9.33) (2.94) 29.55 59.65 (5.86) (49.81)Manufactures 10.64 13.45 20.01 20.88 30.29 20.26 25.62 20.37Elec. & Elec. Eqpt/Parts & Telecom 16.75 20.06 28.99 40.35 48.74 34.76 30.65 31.44Garments 4.79 14.99 6.17 4.53 8.21 (5.72) (3.05) 0.30Special Transactions (10.53) 117.65 2.70 94.74 45.95 45.37 67.52 18.25Re-exports (13.68) 19.51 68.37 9.70 50.83 21.61 54.22 43.16TOTAL EXPORTS 7.99 11.19 15.73 18.53 29.40 17.75 22.81 16.9213

while the two industries contributed substantially to the total export receipts, they are also themajor users of such receipts through imports of their raw material requirements. In net terms,their contribution to the total export value has been minimal.Although total exports grew by about 17 percent in 1997-98, the traditional exportproducts (e.g., coconut, sugar, fru<strong>its</strong> <strong>and</strong> vegetable, etc.), have generally been in a dismal stagewith only sugar <strong>and</strong> sugar products showing a positive growth rate of 1.01 percent in 1997-98(Table 5).In the last two years, machinery <strong>and</strong> transport equipment replaced the garment industry asthe second largest contributor to the total export value. In 1998, it contributed 11 percent of thetotal export receipts. The electronics industry, however, continues to contribute substantially tothe growth of the export sector. In fact, it contributed about 58 percent of the total export valuein 1998.Although the Philippines showed the highest export growth in 1998 compared to otherAsian countries, it is one of the few (including India <strong>and</strong> Sri-Lanka) countries still experiencing anegative balance of trade. This continuous negative balance of trade despite a significant increasein export is due to the import dependence of the export sector for their inputs.POLICY REFORMS TO STABILIZE PRICES AND SUSTAINECONOMIC GROWTHUnder a free market system, <strong>price</strong>s of basic commodities are determined by dem<strong>and</strong> <strong>and</strong>supply conditions. Domestic supply, is, in turn, determined by domestic production <strong>and</strong>foreign trade. Measures that promote, therefore, domestic production <strong>and</strong> improve access toforeign supplies of commodities can help stabilize <strong>price</strong>s. This implies that a more liberalizedtrade regime is beneficial towards <strong>price</strong> stability.The government, through <strong>its</strong> various agencies, is pursuing production-related programs<strong>and</strong> has instituted policies to enhance productivity, efficiency, <strong>and</strong> competitiveness. Theseinclude production programs, training, provision of basic infrastructure like irrigation <strong>and</strong> farmto-market roads, shipping ports, storage <strong>and</strong> post harvest facilities, credit, etc. There are alsolong- term programs such as increased agricultural research expenditures. For agriculture, theproductivity <strong>and</strong> efficiency enhancing <strong>measures</strong> are contained in the Agricultural <strong>and</strong> FisheriesModernization Act (AFMA).Measures to improve competitiveness such as improved productivity <strong>and</strong> efficiency ofthe country's products in the world market are also beneficial in terms of <strong>price</strong> stability. Therecent commitment of the country to the World Trade Organization (WTO) has, thereforeimproved the country's chances of achieving <strong>price</strong> stability through trade liberalizationparticularly of basic commodities. When the country is in short supply of a certain commodity, amore liberalized trade regime would prevent a large hike in domestic <strong>price</strong>s.14

It appears then that while <strong>price</strong> <strong>stabilization</strong> is the prime responsibility of the BSPthrough the prudent use of monetary policies, fiscal policy also plays an important role, not onlyin terms of appropriate tax <strong>and</strong> expenditure policies but also specifically in fostering a moreconducive economic environment within which producers in agriculture <strong>and</strong> non-agriculture areoperating. The possible <strong>measures</strong> which can help combat inflation <strong>and</strong> promote <strong>price</strong> stabilitywithin the country are as follows:Production-related MeasuresFor the years 1993-1998, the agriculture sector exhibited relatively low levels <strong>and</strong> growthof productivity. Average annual growth rates in yield for palay <strong>and</strong> corn were only 0.6 percent<strong>and</strong> 2.8 percent respectively. Abaca, coconut, <strong>and</strong> sugarcane had negative rates; 5.6 percent, 0.2percent <strong>and</strong> 5.3 percent, respectively, pulling the agricultural sub-sector's productivity to anegative rate of 7.2 percent. (Table 6). The limited <strong>and</strong> inefficient provision of support serviceswas a significant factor to low level <strong>and</strong> growth of agricultural productivity in the country.Irrigated l<strong>and</strong> only slightly increased. Inadequate postharvest facilities were manifested insignificant postharvest losses <strong>and</strong> the poor infrastructure impeded the flow of agriculturalcommodities (Medium-Term Development Plan 1999 - 2004, NEDA).Table 6. Average growth in yield (MT/ha.) for agricultural crops, Philippines, 1993-1997Sub-sectorAverage Annual Growth1993-1997AGRICULTURAL CROPS (7.2)MAJOR CROPSPalayCornCoconutSugarcaneBananaPineappleCoffeeMangoTobaccoAbacaOther Crops(12.2)0.62.8(0.2)(5.3)1.917.6(0.8)6.00.4(5.6)7.0Source: Report on the Performance of Agriculture, Bureau of Agricultural Statistics.15

Some economists predict that the country will bounce back from the economic crisis bythe end of 1999. However, the rate of economic recovery will depend on the government policyadjustments in order to improve the balance of payments, lower inflation rate, <strong>and</strong> sustaineconomic growth. Favorable weather condition, which is an exogenous factor <strong>and</strong> theimprovement in peace <strong>and</strong> order condition are also considered important to promote stability inoutput. While the immediate concern of the government is to address the economic vulnerabilityof the country brought about by the financial crisis, long-term solutions to lower inflation rate<strong>and</strong> sustain economic growth should be given top priority. Some of the production-related<strong>measures</strong> are as follows:1. Increase investments in infrastructure <strong>and</strong> research <strong>and</strong> development. Studies in therole of infrastructure in Mexican Economic Reform (Feltenstein <strong>and</strong> Ha, 1995) haveshown that improvements in infrastructure (e.g., electricity <strong>and</strong> communication) helpincrease output <strong>and</strong> stabilize <strong>price</strong>s. Improvement in road <strong>and</strong> infrastructure facilities isa pre-requisite to the social <strong>and</strong> economic development of the country. Improvements ininfrastructure would enable producers to reduce the unacceptable high cost of marketing<strong>and</strong> in some cases, even open up access to market for remote producers/farmers.Furthermore, it would minimize the delays in the delivery of goods <strong>and</strong> services <strong>and</strong>boost production <strong>and</strong> thereby increase the income of small producers without necessarilyincreasing the <strong>price</strong>s of their products.To help facilitate the improvement of infrastructure, the Department of Trade <strong>and</strong>Industry (DTI), the Department of Agriculture (DA), <strong>and</strong> Local Government Un<strong>its</strong>(LGUs) can assist the Department of Public Works <strong>and</strong> Highways (DPWH) in settingpriorities for infrastructure development in areas where lack of transport <strong>and</strong> otherproduction <strong>and</strong> post-production facilities are major constraints in increasing food supply.2. Increase irrigation investment. Investment in irrigation includes new irrigationdevelopment <strong>and</strong> rehabilitation of existing irrigation systems. New irrigationdevelopment will result in the conversion of rainfed areas to irrigated l<strong>and</strong>s <strong>and</strong> marginalto productive l<strong>and</strong>s. With the increase in area planted <strong>and</strong> cropping intensity due toavailability of water, agricultural production is expected to increase. The impact of thedrought brought about by the “El Niño phenomenon” could have been minimized if asuitable irrigation system had been developed. More l<strong>and</strong>s devoted to agriculturalproduction will increase food supply <strong>and</strong> stabilize <strong>price</strong>s.3. Provide proper incentives to the financial sector to increase their credit exposure inthe agricultural sector. The anticipated favorable effect of the devaluation of the pesoon exports was not felt because of the tightening of credit due to higher interest rate. Withhigh cost of credit, small exporters could not exp<strong>and</strong> their capacity <strong>and</strong> could not affordto increase their imported inputs. The availability of credit to small producers is essentialfor sustained economic development through increased productivity. The availability oflow cost credit to small producers will reduce the cost of production thus easing thepressure to increase the <strong>price</strong>s of their commodities.16

The expected increase in productivity will depend on the following conditions: (1)the level of credit availed by the producers is sufficient to purchase the optimal level ofinputs; (2) the loan is used for the intended purpose; <strong>and</strong> (3) the added return in the useof credit is sufficient to pay the added cost of credit4. Increase the role of informal lenders in the provision of credit. The governmentshould also adopt <strong>measures</strong> to encourage informal lenders to continue offering loans butat reasonable rates to small producers/farmers. This can be done also by supporting theinformal credit lenders by providing proper incentives. In addition, the governmentshould help establish cooperatives <strong>and</strong> associations among small producers <strong>and</strong> build upfunds through savings <strong>and</strong> government bank rediscounting. With more credit available tosmall <strong>and</strong> medium producers, supply of commodities will be increased which will resultto stable <strong>price</strong>s.5. Diversify food production. Since the country is always a host to strong typhoonswhich destroy agricultural crops, it is important to diversify production of agriculturalcrops other than the traditional crops that are vulnerable to weather-related disturbances,such as root crops. It is also important to develop such other areas that are less affectedby typhoons <strong>and</strong> other weather disturbances, such as Mindanao. However, this wouldrequire investments in infrastructure investment as well as resolving the peace <strong>and</strong> orderproblem. This program will help increase the supply of food commodities <strong>and</strong> stabilize<strong>price</strong>s.6. Develop the post-harvest sector. The government should support the development ofthe post-harvest sector in order to reduce losses <strong>and</strong> improve the quality of agriculturalcommodities. With improved post-harvest facilities, producers can avail of the incentivesof adopting post-production practices <strong>and</strong> technology, thus increasing their incomewithout increasing the <strong>price</strong>s of goods <strong>and</strong> services. In addition, reducing losses throughimproved post-harvest facilities <strong>and</strong> technologies would clearly increase food availability<strong>and</strong> stabilize <strong>price</strong>s in the country. The government should require the activeparticipation of different agencies involved in post-harvest development. A lead agencyshould be assigned to coordinate the efforts of different agencies/institutions to facilitatethe development of the post-harvest sector.7. Liberalize trade in food. The government should continue to liberalize the trade in foodcommodities. If we cannot source low-cost supplies of food domestically, then we mustbe prepared to procure low-cost food from the world market. However, the governmentin liberalizing the importation of food items should allow the private sector to participateactively in the importation of agricultural commodities (e.g., grains <strong>and</strong> sugar) duringtimes of shortage <strong>and</strong> export during the surplus period. Opening the international marketto the private sector would create incentives for quality improvement <strong>and</strong> employmentopportunities in the country. In addition, the government should help producers of foodto be self-reliant. With sufficient supply of commodities, <strong>price</strong>s will be stabilized.17

8. Provide a more effective <strong>and</strong> efficient market information system (MIS). The MISmust be strengthened to improve marketing efficiency through effective dissemination ofrelevant information pertaining to production <strong>and</strong> marketing. It is envisioned thatstrengthening the MIS will create a more competitive environment among interestedparties – producers, traders <strong>and</strong> consumers- thus improving their economic welfare.Effective <strong>and</strong> efficient market information will decrease the cost of marketing, thuseasing the pressure to increase <strong>price</strong>s. Furthermore, such information system would bevery useful for facilitating the intra- <strong>and</strong> inter-regional trading of commodities in thecountry which would help stabilize <strong>price</strong>s.An example of this is the Electronic System of Trading Agricultural Products program ofthe National Food Authority (NFA) to help facilitate the transaction of corn buyers <strong>and</strong>producers by reducing transaction cost. Corn buyers normally located in Metro Manila<strong>and</strong> Cebu can transact business with local corn producers located in Mindanao <strong>and</strong>Northern Luzon without spending hundreds of pesos. This program can also be adoptedto other agricultural commodities <strong>and</strong> sectors of the economy.Fiscal <strong>and</strong> Monetary ReformsMacroeconomic management has improved a lot in the Philippines since the Marcosyears. The BSP was made an independent institution. Second, the government had privatized alot of money-losing state enterprises, which had drained government finances. However, thesepolicies are not enough to cushion the impact of economic crisis. More reforms in monetary,fiscal, exchange rate, <strong>and</strong> trade policies should be adopted.1. Institute further reforms in financial markets. Measures to boost domestic savingsshould be adopted by the government. In addition, <strong>measures</strong> to attract foreign investorsshould also be implemented. Attracting foreign investors can be achieved by improvingthe stock market operations through transparency <strong>and</strong> efficiency in <strong>its</strong> operations. Smallinvestors should likewise be protected to ensure the continuity of their participation in thecapital market.The government should try to tap other financial institutions (e.g., insurance <strong>and</strong>pension companies) to boost domestic savings <strong>and</strong> help cater to the long-term investmentrequirement of the country. A neutral <strong>and</strong> unbiased tax system will also encourage otherfinancial institutions to augment domestic savings. The policy of government ofencouraging mergers among financial institutions is a big help in attaining stability in thefinancial system.2. Develop the export sector. The export sector plays an important role in attainingpositive growth in the current account. The performance of the export sector during thefinancial crisis indicates that the development of the export industry as a source of growthin the current account is more sustainable in the long-run than relying on the remittancesof overseas workers.18

With the devaluation of the peso, holding other factors constant, this should makePhilippine exports competitive in the world market. However, during the financial crisis,exporters were not able to take advantage of the opportunities due to the lack of capital<strong>and</strong> other markets that were not affected by the financial crisis. The government shouldhelp develop other markets for Philippine exports to minimize the impact of economicdisturbances. In addition, the government should assist the export sector in improvingthe skill <strong>and</strong> capabilities of their workers to be efficient in the production of their output.Likewise, the government should help promote the country's export products in othercountries that are not importing Philippine products.3. Broaden the tax base <strong>and</strong> improve efficiency in tax collection. The budget deficitexperienced by the country for so many years was partly attributed to low tax collection.Government budget defic<strong>its</strong> if not corrected, sooner or later, have to be financed throughmoney creation, which is inflationary. With the broadening of the tax base <strong>and</strong> efficienttax collection, the fiscal deficit could be minimized thus easing the pressure on interest<strong>and</strong> exchange rates which will help stabilize <strong>price</strong>s.4. Institute BSP Monetary Measures. The BSP has at <strong>its</strong> disposal a number of monetarypolicy <strong>measures</strong> that can eventually influence the movement of <strong>price</strong> levels. Theseinclude regulation of money supply, prime interest rates, <strong>and</strong> reserve requirement rates.While these are usually used to influence credit conditions, the investment climate, <strong>and</strong>eventually output <strong>and</strong> employment, these variables can also be used to influence inflationrates. The BSP has kept <strong>its</strong> h<strong>and</strong>s off the dealing floor, allowing the peso to fluctuate <strong>and</strong>seek <strong>its</strong> market rate. While a strong peso can be used to dampen inflationary pressures,this policy is only correct to an extent in the short term. Furthermore, the cause ofinflation should be determined. The current inflation is not a monetary phenomenon buta cost-push one combined with <strong>and</strong> “El Niño” supply shock or a structural defect. Inaddition, the BSP should be more active in monitoring <strong>and</strong> supervising the financialsystem to prevent defaults in the banking system (e.g., Orient Bank, Monte de Piedad,etc.).Issues on the Adoption of Inflation Targeting In Developing CountriesInflation targeting is a framework that be used to conduct monetary policy in order tomaintain a low <strong>and</strong> stable rate of inflation. Its adoption would indicate the strongest possiblecommitment by the monetary authorities to deal with the danger of inflation.In an internet article entitled "The Eternal Triangle", Krugman (1999) argued thatcountries face a dilemna in choosing <strong>its</strong> monetary regime. The three main goals of adjustment,confidence <strong>and</strong> liquidity conflict with one another; choosing one implies dropping the otherobjective. Following Krugman's definition of the three objectives, it looks like the Philippinegovernment is trying to strike a balance between the above-mentioned goals. It is allowing thepeso to float, while keeping interest rates low <strong>and</strong> inflation at manageable rates. In effect, theadministration is putting a premium on adjustment <strong>and</strong> liquidity, but at the same timemaintaining a relatively stable exchange rate by allowing the currency to float within a b<strong>and</strong>.19

The country has recently presented to the International Monetary Fund a new economicprogram with higher growth rates <strong>and</strong> lower inflation. The Estrada administration is expectinginflation to go down to 7- 8 percent this year. Next year, inflation is projected to go down to 6.5percent. The rise in consumer <strong>price</strong>s would be slower this year <strong>and</strong> next year, with sufficientfood supply, a stable peso <strong>and</strong> a modest current account surplus. The government’s thrust ofeasing interest rate has likewise set the phase for a more positive business environment.Unlike other countries, such as Canada <strong>and</strong> New Zeal<strong>and</strong>, the Philippines, has notadopted an explicit inflation target whereby monetary <strong>and</strong> fiscal policies are adjusted in responseto an external shock in order to maintain a specific inflation rate. It appears, however, that thetarget rate of inflation is currently somewhere in the neighborhood of 9 percent.With an inflation target, the response of the BSP to a shock that pushes inflation above <strong>its</strong>target would be to take action to return the inflation rate to <strong>its</strong> target. In this scenario, the <strong>price</strong>level would rise as a result of the initial shock, <strong>and</strong> then the rate of increase in the <strong>price</strong> levelwould be reduced until it would again equal the target rate of inflation. Thus, the initial increasein the <strong>price</strong> level would not be reversed, <strong>and</strong>, there would be a permanent rise in the <strong>price</strong> level.However, there are several prerequisites that have to be met in recommending theadoption of core-inflation targeting. For inflation targeting to work, the BSP has to haveoperational autonomy for monetary policy, a mechanism whereby the BSP is held accountablefor maintaining inflation within the target range, <strong>and</strong> a strategy for the transparentcommunication of monetary policy objectives <strong>and</strong> actions to both financial markets <strong>and</strong> thegeneral public. By raising the profile of inflation, it will focus the attention of monetary policymakers on the difficult decisions to be made. For political establishment, the explicit character<strong>and</strong> transparency of the monetary policy arrangement will be helpful in focusing the debate onthe longer-term objectives of monetary policy. For the financial markets <strong>and</strong> the public at large,the new framework is a key element in establishing expectations of low inflation. A clear target,together with the transparency <strong>and</strong> frequency of the central bank’s public reports on monetarypolicy will allow financial markets to better anticipate the emerging stance of monetary policy<strong>and</strong> thus, reduce surprises.These same prerequisites are mentioned in an internet article on inflation targetingwritten by Masson, et. al. (1998). These include the following: (1) the central monetaryauthority must have degree of independence <strong>and</strong> not show any symptom of financial dominance;<strong>and</strong> (2) authorities should refrain from targeting nominal variables, such as the nominalexchange rate since a country which chooses a fixed exchange rate effectively subordinates <strong>its</strong>monetary policy to the exchange rate objective. In addition to the above prerequisites, amonetary policy framework with essential features needs to be in place. Among the sevencountries that have so far practiced inflation targeting, a number of features are similar. All theseven countries introduced inflation targeting when the inflation rate was already low. Inaddition, inflation targeting is associated with a high degree of exchange rate flexibility <strong>and</strong> allinflation targets were forward-looking.20

Before advocating the adoption of core-inflation targeting in the country, the followingquestions should, therefore, be posed: Does the Philippines meet the above criteria? Is the BSPcapable of conducting an independent monetary policy? Will inflation rates continue to remain ata single digit level? In relation to the degree of Central Bank independence in the developingcountries, Masson, et. al. found out that fiscal dominance <strong>and</strong> poor financial infrastructure donot bode well for an independent monetary policy in developing countries. Apart from thesefindings, Masson, et. al. also raised the following additional issues against the adoption of coreinflationtargeting by developing countries:"1. In most developing countries, there is no consensus about the optimum inflation rate,which is one of the bases for setting the medium-term inflation target. Consequently,any choice of such a target for developing countries might be seen as arbitrary;2. There is also no agreement on the speed with which the medium-term inflation targetwould be attained in these economies. Some observers have argued that once adeveloping country has brought down inflation to within the low-to-moderate range,it should adopt a cautious approach to disinflation;3. The choice of a <strong>price</strong> index on which to base the inflation target is also likely to bemore problematic in developing countries than in industrial economies, since theformer tend to be subject to more numerous <strong>and</strong> variable supply shocks that affect the<strong>price</strong> index <strong>and</strong> inflation; <strong>and</strong>4. In many developing countries, administered or controlled <strong>price</strong>s are an importantcomponent of aggregate <strong>price</strong> indices <strong>and</strong> thus, of the short run behavior of inflation.In such cases, a proper inflation forecast would need to take account of the timing <strong>and</strong>extent of changes in those <strong>price</strong>s. This would require a higher degree of coordinationbetween monetary <strong>and</strong> fiscal authorities than in situations like those in industrialcountries where most markets are market determined."Based on the foregoing discussions, it is apparent that the preconditions for adoptingcore-inflation targeting are not yet present in most developing countries like the Philippines.The issue on the degree of independence of the central monetary authority <strong>and</strong> the lack ofagreement on the optimum inflation rate, the choice of a <strong>price</strong> index, <strong>and</strong> the speed with whichthe inflation target should be attained complicate the approach of inflation targeting in thecountry.CONCLUDING REMARKSThe <strong>price</strong> <strong>stabilization</strong> <strong>measures</strong> enumerated above which take the form of productionrelatedas well as fiscal <strong>and</strong> monetary policies will enable the Philippine export sector to weatherfuture crises <strong>and</strong> improve their global competitiveness. Solving the structural bottlenecks inproduction with reforms in the credit market <strong>and</strong> infrastructure will reduce <strong>price</strong> movements.Furthermore, reducing the costs of doing business in the country by fostering a climate of stable<strong>price</strong>s will improve the marketability <strong>and</strong> attractiveness of Philippine-made products. While thisis not the panacea for the multitude of problems that confront the export sector, these <strong>measures</strong>will significantly promote the growth of the industry.21

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