Time Bomb

The country faces a fiscal crisis in two years, yet only one new tax measure has been enacted

The good news is that for the second straight year, the national government’s fiscal deficit in 2004 was lower than 2003’s and even lower than expected for 2004. Without collecting new taxes in 2004, the deficit slid to an estimated 3.9% of GDP (equivalent to at least P186.1 billion) from 4.6% (P199.9 billion) in 2003, on track with the government’s goal of balancing the budget by 2009.

UP School of Economics professor Winnie Monsod and her colleagues ring the alarm bell over the mounting fiscal deficit

The bad news is that the national government absorbed some P200 billion of National Power Corporation’s P600 billion outstanding debt at yearend. With this, the deficit target for 2005 has been raised to P193.3 billion from P184.5 billion.

In January 2004, Standard Chartered Bank’s Chief Economist, Steve Brice, warned that “an uncontrollable debt spiral is unlikely but not impossible” in the Philippines “given the already high level of public debt.” According to his study, “there is evidence of a vicious cycle emerging, with almost half of government revenues being used to service the debt.” Aware of the situation the country was getting into, Bangko Sentral Governor Rafael Buenaventura emphasized that whoever will be elected president in the May 2004 elections needs to impose new taxes, raise tax collection, and eliminate smuggling.

Before Congress convened in July 2004, President Arroyo told the business community she intended to raise P80.0 billion from eight revenue measures: gross income tax system, repeal of the VAT, tax on windfall income from telecom companies, increasing revenues from sin products and petroleum products, rationalization of fiscal incentives, a “targeted” tax amnesty, and the creation of a performance-driven system for revenue agencies. She also promised to raise some P20 billion from administrative measures, including a pending reorganization of government agencies. She likewise issued Executive Order 336, raising tariffs on imported crude and refined petroleum products to 5% from 3%.

In August, a team of 11 economists from the University of the Philippines School of Economics warned that the country would face an economic collapse in two years if the government failed to adopt drastic measures to address the twin problems of the fiscal deficit and the public debt. To avoid a full-blown fiscal crisis, they prescribed that government should keep or reduce its debt-to-GDP ratio -- currently at 78% (P3.4 trillion as of end-2003). In response, President Arroyo announced the country was in the midst of a fiscal crisis. The declaration would have justified a freeze in hike in internal revenue allocations to P141 billion instead of P151 billion. Compared to the national government, however, local government units actually posted a collective surplus of P19.3 billion from January to September 2004. For their part, some legislators initially offered to cut or give up their “pork barrel” allocations.

In November, the President turned around, declaring the country out of fiscal crisis. The Bureau of Customs supported that claim, having met its revenue target. But other indicators pointed otherwise. The Bureau of Internal Revenue, which marked its centennial with a taxpayer recognition program, missed its target collection by P6.3 billion. By yearend, only one revenue measure – out of the eight the President identified -- was signed into law. Though watered down, Republic Act 9334, on the so-called sin taxes on alcohol, cigarette, and tobacco products promises to deliver P14 billion in new revenues per year starting 2005. Contrary to original expectations, this major legislation, however, was not enough to avoid credit rating downgrades from Moody’s and Standard and Poor’s in January 2005. In December 2004, Fitch Ratings changed its ratings outlook on the Philippines to negative from stable.

In the meantime, the government continues to operate under last year’s general appropriations level since the proposed 2005 national budget of P907.6 billion remains pending in the Senate. The proposed debt service allocation for interest payments alone has increased to 33.2% of the budget (P301.7 billion) for 2005 from 31.5% (P271.5 billion) programmed in 2004. This has further compressed government’s budget for operations.

Under the government’s fiscal roadmap for the medium-term, the public debt will be reduced through a bond exchange, the use of Official Development Assistance, limited guarantees to government corporations, a debt cap, and limited borrowings to high priority projects. In December 2004, the Finance Department created an agency – the Debt and Risk Management Office – that will do a comprehensive risk analysis of borrowings of government and government corporations even before the borrowings are incurred.

The proof of the pudding as they say, is in the eating. As the UP professors state, it remains to be seen “whether the nation’s institutions and the quality of its leadership will suffice to save its people from an impending ordeal that has been largely predicted.”