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Vol. XVIII No. 6

November - December 2000

ISSN 0115-9097

The President's 2001 budget: Making difficult choices* Rosario G. Manasan**


hould there be a change in the administration in the coming months,1 the incoming president will be confronted with similar situations which welcomed her three predecessors. More than 14 years ago,

then incoming President Corazon C. Aquino was faced with a bur-

geoning debt problem on top of other economic misfortunes when she assumed office after the depose of former President Ferdinand Marcos. Six years after, she handed down the presidency and an energy crisis to confront with to incoming President Fidel Ramos. Still later, current President Joseph Ejercito Estrada was elected in the middle of a regional financial crisis and a whole lot of economic problems. If the tide turns against President Estrada in 2001 and the present administration will turn over the reins—willingly or not—to Vice-President Gloria Macapagal-Arroyo, it will be leaving behind a huge fiscal deficit that

The financial mirror The government budget, which may be viewed as the financial mirror of society’s economic and social choices, is supposed to contribute to the attainment of the overall objectives of economic policy, namely, growth, equity and stability. There is a general consensus that these goals are complementary over the long term: economic growth provides the resources for poverty reduction; unstable macroecoto page 2

is projected to exceed the P85 billion target.

*Condensed version based on PIDS Discussion Paper 2000-43. **Senior Research Fellow at the Philippine Institute for Development Studies (PIDS). 1 Various sectoral groups have demanded the resignation of President Joseph Ejercito Estrada who has been accused of, among others, receiving payoffs from jueteng, an illegal numbers game in the country. However, President Estrada has reiterated countless times that he will not resign and instead, will wait for the decision of the impeachment court composed of 21 senator-judges and the Supreme Court chief justice.

How, then, will this shortage be treated in the President’s budget for 2001?

What's Inside 6

Exchange is no change: Is oil deregulation a failure?


What is oil deregulation?


The interest rate cure: Here we go again

Editor's Notes The countdown for the Philippine economy—if not the whole nation—started a few months ago with former Ilocos Sur Gov. Chavit Singson's allegations that President Joseph Ejercito Estrada receives jueteng pay-offs. Too damaging to the country and the image of the Philippine president, the allegations set the wheel in motion. What's going to happen next? to page 15


Budget... From page 1

nomic policies undermine sustained growth and hurt the poor most2; and stability with economic stagnation and worsening poverty is meaningless (ADB 1999). However, in the short run, these goals may be in direct conflict with one another and difficult choices have to be made. For the government to function well and fulfill its roles, it must collect sufficient resources and allocate these resources efficiently and effectively. This implies an integral relationship between revenue and expenditures—the two principal elements of fiscal policy. Thus, the President’s budget proposal for 2001 may be evaluated in terms of two principal objectives of good public expenditure management: fiscal discipline and strategic allocation of resources.


2000, the fiscal deficit has already reached P83 billion or P20.5 billion higher than the initial estimate. The ballooning of the deficit is due to two major factors, namely: j Shortfall in revenue collections amounting to P38.8 billion. This figure already includes some P1.5 billion in additional revenues expected from tax on interest on treasury bills due to higher domestic interest rates in the 4th quarter.

President Joseph Ejercito Estrada: Tough decisions to make in 2001

The national government 's fiscal deficit for 2000 was initially targeted to reach P62.5 billion or 1.38 percent of the gross national product (GNP). However, by the end of September

Low growth (or worse, no growth) not only reduces the poor’s access to jobs and other means of livelihood, but the inflation tax is also regressive. 2

Aggravating the situation were the unanticipated depreciation of the peso and the rise in domestic interest rates in the last quarter of 2000. The latter is expected to cost the government an additional P9.4 billion in interest payment. Given this, the author projects that the deficit for 2000 will reach P117.2 billion. Moreover, if local government units (LGUs) succeed in challenging the recently imposed (beginning in October 2000) new internal revenue allotment (IRA) release schedule of the Department of Budget and Mangement (DBM) wherein the IRA for a particular month is disbursed in the first week of the following month instead of the original practice of the first week of that particular month, then the above projection of P117.2 billion may even go up to about P127.3 billion.

What is in store for 2001? For 2001, the proposed President's budget projects the fiscal deficit to be P85 billion or 2.2 percent of the GNP. This early, however, it is obvious that the target is unrealistic for two reasons.

Fiscal discipline requires good revenue forecasts and aggregate expenditure controls while resource allocation is assessed in terms of its consistency with the government’s policy pronouncements. In particular, the second is appraised in terms of the manner by which government expenditures are programmed across sectors and categories in order to promote overall economic growth and equity.

What happened in 2000?

November - December 2000

AsiaWeek, 20 October 2000

j Unsuccessful disposal of government shares in the Philippine National Bank (PNB), Manila Electric Company (Meralco), and the Philippine National Oil Corporation-Energy Development Corporation (PNOCEDC) as originally planned. Only P1.9 billion has been realized as of the end of September from the targeted P22.9 billion privatization proceeds.

First, the macroeconomic assumptions have to be modified given recent developments. In this regard, changes in the exchange rate and domestic interest rate assumptions are critical. In our projections, the pesodollar exchange rate is assumed to settle at an average of P48 and the 91-day T-bill rate at 11 percent while the GNP is assumed to grow by 4.5 percent in real terms and inflation to reach 6.5 percent. The Budget of Expenditures and Sources of Financing (BESF), on the other hand, projected a peso-dollar exchange rate at only P42 and a T-bill rate at 9.5 percent. Second, the BESF's BIR tax projections appear to be overly optimistic. Based on our projections (Table 1), the



November - December 2000

Table 1. National government fiscal position (In P billion)


Revenues Tax revenues BIR BOC Other offices Nontax revenues Disbursements

BESF Program 2000

Author's Projections Difference a 2000 2000

BESF Program 2001

Author's Author's Projections Projections (high rev.) Difference a (low rev.) 2001 2001 2001

Difference a 2001

























































Current operating expenditure










Capital outlays


















(Percent of GNP)









Difference = BESF target less author's projections

national government’s fiscal deficit in 2001 will range from P124.1 billion (3.2 percent of GNP) to P143.3 billion (3.7 percent of GNP). The difference between these two estimates stems from varying assumptions on BIR tax collections. A tax effort ratio assumed to remain at the 2000 level will result in a projected revenue collection of only P401.2 billion. However, if the tax effort improves or rises even by just 0.5 percentage point, then BIR revenues may reach P420.4 billion. If these projections are compared with the BESF target of P441.6 billion, then the BIR collections are likely to fall short by some P16.9 billion to P36.2 billion in 2001.

lion revenue loss from the suspension formance exhibited some vigor from of the 3 percent duty on oil imports by 1986 to 1997, the regional financial criJanuary 2001. Similarly, the higher in- sis exacted a heavy toll on tax revenues. terest rate assumption for 2001 implies Tax effort plummeted from 16.3 perthat the BESF's projected Bureau of cent of GNP in 1997 to 14.8 percent in Treasury income will exceed by P3.6 billion. At the same time, though, the to page 4 rise in the foreign exchange rate, the higher T-bill rate and the larger debt stock Table 2. National government revenues as a proportion of GNP (In %) carried over to 2001— because of the higher 1997 1998 1999 fiscal deficit in 2000— will shift the national Total revenues 18.66 16.43 15.16 government interest payments upwards by Tax revenues 16.30 14.80 13.68 P28.2 billion.

There are, however, indications of possible gain as a result of the depreciating peso. This is seen in the Bureau of Customs' (BOC) likelihood to exceed its target revenue by P3.6 billion, even with an estimated P0.4 bil-

Major problem: Where to get funds Although the national government’s revenue per-

















Other offices




Nontax revenues





President's budget... From page 3

1998 and down to 13.7 percent in 1999 (Table 2). Low tax revenues persisted despite the turnaround in economic activity. There was a downward shift in the tax elasticity ratio (or the ratio of percentage change in tax revenues to percentage change in GNP) due to, for one, a persistent reduction in revenues from corporate income tax brought about by the presence of corporate foreign currency debt and the lower demand for imports. These two factors can be tied to the depreciation of the peso. In addition, there loom bigger problems with regards to revenue generation. First, the rate of tax evasion from both individual income tax (60.81% in 1999) and the value-added tax (VAT) on domestic sales (62.61% in1999) had gone up since 1995 (Table 3). Second, various groups have pressed for the reduction in the income tax base. The responses came in the form of two bills submitted to the


Table 3.

November - December 2000

Level of tax evasion from individual income tax and from VAT on domestic sales (1990-1999) Individual income tax Evaded taxes (P million)

VAT on domestic sales

Evasion rate (%)

Evaded taxes (P million)

Evasion rate (%)



















































Sources: 1990-1995, Manasan (1998); 1996-1999, Manasan (2000)

House: the Suarez bill, which proposes for the reduction of excise tax on petroleum products by 20 percent, and the Enrile bill, which proposes for an increase in the personal exemption level and the marginal tax rates for the individual income tax. These proposDelaying payment for completed services or delivered goods may have als are expected to a corresponding effect on the measure of the fiscal impulse. result in revenue losses of P6 billion and P69 billion, respectively.

Reuters in BusinessWorld Top 1000, Vol. 14, 2000

Financing government programs and projects will thus be an exercise of excellent fiscal discipline and management in 2001. Moreover, with the continuing depreciation of the peso and a huge fiscal deficit to be carried over from 2000, the government is ex-

pected to shift back to domestic financing in the coming year. In fact, the 2001 program proposes that 71.6 percent of the total borrowings will come from domestic sources.

Impact of fiscal policy on aggregate demand and growth At this point, it is useful to take a look at the first-round contribution of the fiscal policy (expenditure cum tax policy) to the growth in aggregate demand using the fiscal impulse measure. A positive fiscal impulse implies an expansionary fiscal policy relative to the previous year where new economic activities or pump-priming efforts are seen to have contributed to greater output. Conversely, a negative fiscal impulse connotes a contractionary fiscal policy. What is the fiscal impulse to be expected in 2001? In order to answer this, we have to examine the use by the government of arrearages as a financing instrument. Normally, the government pays for its obligations when the goods and services they represent are


completed and delivered. However, if payment for these completed services or delivered goods are delayed and not treated as part of the national government expenditures, then such accounts payable are said to be used as a financing instrument or item. This will then have a corresponding effect on the measure of the fiscal impulse. In 1998, the national government accumulated a substantial amount of accounts payable which recent DBM estimates place at around P151.1 billion. By the end of 1998, what should have in reality been a fiscal deficit of P201.1 billion was reported to be only P50 billion in the Cash Operations Report (COR). The difference of P151.1 billion was financed by arrearages to contractors and suppliers. Hence, more new activities or pump-priming efforts were actually made in 1998 than what is reflected in official statistics. In the subsequent years, the P151.1 billion accounts payable was programmed to be trimmed down gradually. However, instead of treating the retirement of these government arrearages as debt amortization and placed below the line, the amounts were treated as expenditures in these years' presidential budgets. Thereupon, the cash budget in said years does not adequately reflect the true state of the national government’s fiscal position. Based on this, it can be said that the way accounts payable are treated in the budget will determine the level of fiscal impulse for 2000 and 2001. If the planned retirement of accounts payable is netted out of the expenditure program (instead of being treated as part of expenditures as official statistics reflected), then our estimate of the fiscal impulse for 2000 is –2.4 percent of GNP and for 2001 is –0.22 percent of GNP (Table 4). This analysis indicates that using arrearages as a financing tool diminishes the transparency of national government accounts and makes the task of fiscal policy analysis more difficult.


November - December 2000

his election campaign. Upon assumpTable 4. Fiscal impulse, 1995-2001 (Percent to GNP) tion to power, he has since implemented Revenue Expenditure Fiscal national programs impulse impulse impulse that centered on poverty alleviation. For 2001, the pro2000 b -0.94 -1.83 -2.40 posed President’s 2001 b 0.53 -1.39 -0.22 budget appears to follow the same di2000 c 0.44 -1.63 -1.19 rection and ap2001 c -0.43 -0.84 -1.27 proaches poverty reduction from the a perspective of susBased on revenues and expenditure projections of BESF b Retirement of accounts payable treated as expenditures taining overall ecoc Retirement of accounts payable treated as debt amortization nomic growth through productivity This may translate into incorrect policy improvements in the agriculture sector. recommendations since the data on which the analysis were based were misThus, like the President's budgets leading in the first place. Meanwhile, in 1999 and 2000, while the social serthe issue of sustainability is central to vice sectors continue to capture the the survival of the government and its lion’s share in aggregate national govvarious programs. It is therefore impor- ernment expenditures, the proposed tant that the government is able to expenditure program for 2001 shifts remaintain its fiscal sustainability by mak- sources in favor of the economic sering sure that its debt servicing require- vice sectors and general public services ment does not exceed its primary sur- (i.e., general public administration plus plus. peace and order). a

Our estimates show that regardless of whether one uses the BESF projections for 2000 or the more conservative estimates that take into account recent movements in key macroeconomic variables, the picture for 2000 and 2001 does not look as rosy as the fiscal sustainability estimates yield a positive sign, indicating that the actual primary deficit exceeds the sustainable level of the primary deficit. This calls for a more contractionary stance on the part of government. Given the fact that MOOE and capital expenditure levels are already low, the only way government can achieve this without further cutting back on expenditures is by improving its revenue effort.

The 2001 budget at a glance Estrada’s battlecry was Erap Para sa Mahirap (Erap for the Poor) during

What is particularly worrisome about this development is the decline in real per capita national government expenditures on basic education and basic health care despite the reallocation of resources within the social services sector toward basic social services. Given the fact that poor families are largely dependent on publicly provided basic social services, this development does not augur well for government’s poverty alleviation efforts. Also, the allocation for the combined infrastructure sector (transportation and communication, power/energy and water resources development) has continued to stagnate despite indications that the economy’s infrastructure support is one of the major bottlenecks to overall economic growth means that the to page 10



Exchange is no change: Is oil deregulation a failure?* Peter Lee U**


n recent months, international crude oil prices have been rising and consequently, local pump prices have been rising, too. Unfortunately for the oil industry, perhaps no other product in the economy has as wide a clientele, direct and indirect. Everyone has to travel or consume goods that have to be transported and produced using power that, chances are, is generated with oil-based fuel. Not surprisingly, the price increases have sparked widespread protests, even around the world. Witness the recent blockades by truck drivers in parts of Europe protesting high gasoline prices. This certainly suggests that there is a real global underlying problem and that the high prices are not * Paper presented during the Roundtable Discussion on the proposed National Oil Exchange jointly sponsored and organized by the Congressional Planning and Budget Office (CPBO) of the House of Representatives and the Philippine Institute for Development Studies (PIDS) on 21 September 2000 at the Batasang Pambansa Complex. This also appeared as PIDS Policy Notes 2000-12 based on PASCN Discussion Paper 2000-14 entitled "Competition Policy for the Philippine Downstream Oil Industry." **The author is an Assistant Professor at the School of Economics, University of Asia and the Pacific.

simply the work of the so-called local big three (Shell, Petron, and Caltex). Of course, nobody likes to pay more for anything. Thus, various groups have been clamoring for government to do something to alleviate the situation. This has spawned proposals like reducing taxes on fuel and the National Oil Exchange bill of Bataan Congressman Enrique Garcia. The proposed oil exchange (and public sentiment supporting it) seems to be premised on two things.

Dr. Peter Lee U

November - December 2000

One, that deregulation has failed and instead created a monster cartel in the form of the big three that can control and dictate prices. Therefore, government should step back in with some form of regulation such as the oil exchange. And two, that such an oil exchange can actually bring down prices.

Downstream oil deregulation – failure? First of all, what is the rationale for deregulation? A fair assessment of the success or failure of deregulation can be made only with a proper appreciation of its objective. Lower price per se is not the objective of deregulation, though it often does accompany it. The primary reason for deregulation is to improve resource allocation by subjecting decisions to market forces. Deregulation may also attract new players and investment, increasing the amount of competition. As a result, efficiency gains can be realized in the long run. Thus, prices can fall after deregulation, ceteris paribus (i.e., assuming all other factors like exchange rates, crude oil prices, and others remain the same). However, a deregulated market can sometimes also result in higher prices when, for example, the product had previously enjoyed heavy subsidies which are then taken away with deregulation. In the case of oil, there are also other reasons for the price increases. The Philippines produces very little crude oil of its own and must import almost all its needs. Thus, we are subject to the vagaries of international oil price movements, which in turn are determined to a large degree by the Organization of Petroleum Exporting Countries (OPEC) quotas. From the low teens in terms of US$ per barrel as recent as the early part of 1999, crude oil prices have skyrocketed to as much as over US$30 per


barrel in recent weeks. The other important determinant of imported cost of oil is the foreign exchange rate. In recent weeks, the peso has also been depreciating and this has exerted further upward pressure on pump prices.


November - December 2000

Figure 1. Indexed Historical Prices of Imported Crude Oil and Local Pump Prices (Pesos) (January 1998 = 100) 200 180 160 140 120 100

It is true that the big three (Caltex, Petron and Shell) still command the lion’s share of the total market (almost 90%). The new players,

The new players have a long way to go to catch up with the big three here. The new players have about 200 stations versus over 3,000 for the big

On the other hand, industrial sales would require only bulk storage and hauling facilities, both of which are necessary prerequisites anyway for retail distribution. This explains why the new players have been able to acquire 13 percent of this subsector, which is arguably a decent performance given the less than five years in which the market has been opened to them.

M ar





Ju l

M ar

Ja n00



M ay







Ju l

M ay

M ar





Figure 1 shows the 80 relative movements of 60 the peso cost of im40 ported crude oil and lo20 cal pump prices. The se0 ries have been indexed with January 1998 as the base point. Thus, relaPG UG D Crude Oil Cost tive to January 1998, it is very clear that the imported cost of crude oil Legend: PG = premium gasoline has outstripped local UG = unleaded gasoline pump prices. Moreover, D = diesel Department of Energy Source of raw data: Department of Energy (DOE) statistics show that pump prices in Manila are among the lowest in the region, however, have been fairly successful in even lower than Thailand and the U.S. making inroads into portions of that (for unleaded gasoline and diesel). market. In some sectors like LPG, new players’ market share has even reached One sign that the oil industry de- 23 percent, already a bigger market regulation is working is that new play- share than Caltex! ers have come in. Data from DOE show that fuels bulk marketing has the most The retail distribution of gasoline number of new players in operation as and diesel is much more visible to the of June 1999, with twenty four. Retail public. Thus, attention has somewhat marketing was second with thirteen been fixated on this subsector. Here, new players while LPG bulk marketing the new players admittedly have made and terminaling had five and three, re- the smallest dent. As of the first quarspectively. No new player has yet en- ter of this year, DOE statistics show that tered the refining business. Among the they have captured only 5.3 percent of new players are large foreign compa- this market, up nevertheless from 3.9 nies such as Total (French) and Coastal percent last year. This slow market penCorporation (American). The new etration is explained mostly by the fact players have likewise invested P12-15 that to be able to sell in retail, a netbillion. work of gasoline stations is needed.

three combined. Furthermore, each gasoline station can cost anywhere from P10 to P20 million pesos. Thus, the capital requirements of a network of retail gasoline stations are indeed great. Considering the amount of time and capital needed to identify the location, acquire or negotiate leases and construct the stations, it is obvious that it will be some time yet before the new players can capture a more significant market share.

Thus, has deregulation failed? My opinion is that it has not failed. On the contrary, it is working, albeit the slow progress in some sectors. The irony is that going back on deregulation with something like an oil exchange will even discourage the entry of the very same new players that will provide further competition in the future that will loosen the big three’s hold on the market. Moreover, it will further damage our country’s overall investment attractiveness as it lends further fuel to investor perception of policy flip-flopping by government.

Will a National Oil Exchange reduce oil prices? What is the National Oil Exchange? The draft House Bill No. to page 9




he ordinary Filipino driver re cently faced a minor dilemma: Where to gas up? Before, there were only three choices, namely, Petron, Shell and Caltex. Now, new companies like Flying V and Seaoil surfaced in the gasoline arena, each providing attractive incentives for motorists to patronize their products—cheaper petroleum prices, better services and free car washes. The entry of these companies can be credited to the deregulation of the oil industry which resulted from the passage of Republic Act 8479 (Downstream Oil Industry Deregulation Act of 1998) on February 10, 1998. With this law, the Philippine government reduced its control on oil-related pricing activity and trade restrictions.

What is oil deregulation?* Ma. Teresa D. Caparas**

importing crude oil, which is not reflected in the selling price. Consequently, the effects of a regulated oil industry were: j Changes in the world prices of oil and foreign exchange rate were not immediately reflected in the domestic prices. Any large adjustment in oil prices made it difficult for businesses and consumers to adjust quickly, thereby causing disruptions.


j Cross product subsidization1 created imbalances in the demand and supply of petroleum products. Diesel was priced significantly lower, encouraging higher consumption and resulting in a shift in the use from gasoline to diesel.

Prior to RA 8479, the Energy Regulatory Board took into account the dollar cost of imported crude oil and the foreign exchange rate, and fixed prices of petroleum products. A budgetary allocation maintained by the national government called the Oil Price Stabilization Fund (OPSF) automatically absorbed any price change incurred by the oil companies in *This is based on the Institute's Economic Issue of the Day series (February 2000, No. 2) which aims to explain certain economic concepts in simpler terms as they apply to current policy issues. This particular series is part of the Institute's efforts to help in enlightening the public and other interested parties on the concepts behind certain economic issues. By reprinting this series' issue on oil deregulation, the Institute hopes to further broaden the disseminationof said information. **Supervising Research Specialist, PIDS Mc Saparas prepared this in consultation with Dr. Josef T. Yap, Senior Research Fellow at PIDS. Cross product subsidization means that the price of premium gasoline was higher than warranted in order to keep the price of diesel lower. Implicitly, regulation favors diesel product over gasoline. 1

November - December 2000

j Oil companies experienced delays in margin recoveries since any price adjustments would still require public hearings. j Entry of new investors was discouraged, thereby minimizing competition.


j To encourage competition, j To encourage investments, and j To remove cross product subsidies. Pricing of petroleum products was based on the Automatic Pricing Mechanism (APM), a formula that automatically adjusts the price ceiling on local retail oil prices every month, based on the exchange rate and Singapore-posted prices (SPP). Singapore petroleum product prices are used as the basis for local pricing since they are widely published. They also reflect market realities in Southeast Asia since Singapore is the hub of oil trading in the region. Thus, changes in the prices of local petroleum products are highly dependent on the SPP and movement of the exchange rate. A notable observation is that in 1999, the percentage increase in domestic prices was less than what changes in the world price of crude oil and exchange rate depreciation warranted. There is a lag in the response of domestic fuel prices and this implies that there will likely be sharp changes in the early part of 2000.

The deregulation of the local oil industry was done in two phases: partial and full deregulation. In the partial deregulation phase, oil importation was liberalized and the automatic pricing mechanism was implemented. In the full deregulation phase, controls on oil price setting were similarly lifted, the foreign exchange cover was removed, and the OPSF was abolished.

In the absence of pricing regulations, it is of course very tempting for the oil companies to charge the consumers unreasonably high prices. To prevent possible abuse, therefore, the Department of Energy–Department of Justice Task Force was created. This body evaluates the merits of any report of unreasonable petroleum product price increases.

There are four major reasons why the oil industry was deregulated:

RA 8180 also prohibits cartelization and predatory pricing and sets three years’ imprisonment and a fine ranging from P500,000 to P1 million as penalties.

j To stabilize and provide reasonable prices,


Oil exchange... Other countries like Thailand, New Zealand and Japan have also recently deregulated their respective oil industries. Generally, they have had favorable responses where the number of players increased and the price of petroleum products became more competitive.

What’s the difference? After deregulation took effect, prices of petroleum products still continued to rise, prompting many consumers to complain and associate such increases with deregulation. But the price increases were not a direct effect of deregulation. The country has been experiencing oil price increases even before deregulation took effect. The reason: we are a net importer of petroleum. Thus, when prices of petroleum products abroad increase, the local oil industry has little choice but to adopt the rise in prices. The bottom line is increasing oil prices are due to the increases in the world price of oil compounded by the depreciating value of the peso.

Terms to remember j Deregulation generally means the lifting of government control and letting market forces work in the business. For the local oil downstream industry, the concept of deregulation covers price decontrol and removal of restrictions on the establishment and operation of facilities as well as the importation and exportation of crude oil and petroleum products. j Cartelization is any adjustment by refineries and/or importers to fix prices, restrict output or divide markets. j Predatory pricing is the act of selling at a price unreasonably below the industry average cost (i.e., at a loss to deter entry of potential rivals) and later raising the price to recover shortrun losses. DRN

From page 7

12052 conceives of the national oil exchange as a “government-owned and controlled corporation.” It “shall determine the country’s total monthly requirements for refined petroleum products, and shall exclusively handle their original acquisition/purchase, storage and eventual distribution to distributors and wholesalers”, including the big three. This oil exchange “shall acquire/purchase the country’s requirement of each and every refined petroleum through bidding and term contract negotiation open to all oil refineries and traders in the world, in order to obtain the lowest price for said products.” (HB 12052 Sec. 4 and 8) Furthermore, “only the refined petroleum products of the lowest complying winning bidder/s and term contractor/s may and shall be placed in commerce in the Philippines.” This last provision will therefore effectively make it a monopoly seller of refined products to the distributors (the big three and new players). This proposed government entity will naturally require storage facilities for its inventory of refined product purchases. Originally, Congressman Garcia’s proposal had been as extreme as taking over all such facilities in the country, including those privately owned by the big three and new players. He has since toned down this provision and HB No. 12052 [now] stipulates that the oil exchange will “take over and operate the governmentowned ocean receiving terminals and storage depots at Subic and Clark to receive and store all refined petroleum products. For this purpose, the OILEX shall take control of the operation of said facilities subject to the requirements of the Constitution and existing laws. Such facilities shall be used exclusively by the OILEX for the storage and

November - December 2000

distribution of the products of the lowest complying and winning bidder/s and term contractor/s. The refined petroleum products coming from the winning local oil refineries may be maintained in their respective storage facilities, subject to the exclusive control and disposition of the OILEX.” (HB No. 12052 Sec. 7) The concept of a National Oil Exchange seems to make sense intuitively. Anyone who has haggled in a palengke (market)has experienced getting a discount when he buys in bulk or in greater volume. And this is prePhilippine Star, 28 August 2000


cisely what makes it a dangerous idea. The mistake is to extrapolate from this experience and conclude that the same thing will happen with the oil exchange. The mistake lies in forgetting the relative sizes of the Philippine market and the total international market for oil. Oftentimes, our day-to-day haggling experience is limited to encounters with small individual merchants in the flea market or tiangge. Imagine, however, what sort of results you could expect haggling over the price of a couple of shirts with, say, Shoemart. You would probably be asked to take it or leave it. The matter of oil purchase transaction is similar to the latter situation. The total Philippine consumption for oil is estimated at 350,000 barrels per day. In contrast, the world market is estimated to be more than 70 million barrels a day. It is thus very difficult to imagine that we could get any to page 13


President's budget... From page 5

road to improved national economic development may not be that smooth.


November - December 2000

Figure 1. National government expenditures, by sector (Percent to total budget)



Where the funds will go The President’s Expenditure Program for 2001 is expected to grow at a conservative rate of 11.6 percent relative to the actual expenditure program for 2000. Out of this programmed expenses, the IRA will grow by 18 percent and the debt service by 11.6 percent. Figure 1 shows the percent allocation of national government spending across the various sectors from 1986 to 2001. The share of general public services—including general public administration, and peace and order— will rise from 14.0 percent in 2000 to 18.1 percent in 2001. Included in this expanded budget is the planned 5 percent across-the-board salary increase for all government employees in 2001 and the upgrading of the PNP uniformed personnel’s salary. The economic service sector is given special attention in the 2001 budget as its share increases by 14.7 percent and captures 18.4 percent of the national government budget, with the environment and natural resources management subsector standing to gain the most from the increase. On the other hand, the proposed national government spending on the infrastructure subsector (composed of power energy, water resources development and transportation/communication) in 2001 is considerably lower than the 2000 level, even if the adjustments for increased private sector finance of infrastructure projects through the build-operate-transfer (BOT) schemes are included. Nonetheless, the infrastructure subsector continues to capture over 50







0.00 1986

















Economic Services Debt Services

Social Services IRA

percent of the total national government allocation for the economic services sector. Within the subsector, transportation and communications receives the biggest share of the budget but power and energy registers the highest rate of increase.

Gen. Public Services

Meanwhile, the nominal increase in total social service sector spending of the national government in 2001 is not even sufficient to keep pace with inflation. National government expenditure on all the social services sectors combined is projected to register the

Figure 2. National government expenditures, by sector (Percent to GNP) 7.00







0.00 1986

















Economic Services

Social Services

Gen. Public Services

Debt Services


lowest rate of growth at 3.0 percent among the major sectors. Relative to GNP, national government allocation for the social services sector has declined continuously from a peak of 4.9 percent in 1997 to 4.4 percent in 2000 and 4.2 percent in 2001 (Figure 2). Although the social sectors continue to capture the biggest share in aggregate national government expenditures (22.5%) in 2001 as noted earlier in Figure 1, their combined budget share has shrunk from a top mark of 24.9 percent in 1997 and from 23.8 percent in 2000.

November - December 2000

Table 5. National government expenditures as a proportion of GNP, by sectoral and subsectoral classification, 1999-2001 (In percent)

Expenditures as proportion of GNP (In percent) 1999 GRAND TOTAL

On the other hand, the reduction in the allocation for the health subsector is largely due to the reforms aimed at making hospitals more financially independent. However, funding for public health programs has also been downgraded such as the share of preventive health care services in the Department of Health’ s total budget, which contracted from 26.4 percent in 2000 to 24.3 percent in 2001. Total expenditure on the health subsector is down from 0.37 percent of GNP in 2000 to 0.33 percent in 2001 (Table 5). Another subsector badly hit by the contraction in the social services sector as shown in Table 5 is education: its total allocation drops from 3.42 percent of GNP in 2000 to 3.25 percent in 2001. Consequently, expenditures on health and education will post significant reductions in real per capita terms in 2001. Thus, real per capita spending on health and education in 2001 are 8.4 percent and 2.7 percent lower than their 2000 levels (Table 6).



2000 p

2001 f



Total Economic Services








Agrarian Reform




Natural Resources
















Power and Energy




Water Resources Development




Transportation and Communication




Other Economic Services




Total Social Services


















National Defense




Total Public Services




Public Administration




Peace and Order








Debt Service




Social Welfare, Labor and Employment Housing and Community Development

MEMO ITEM: IRA Grand Total - Debt Service

p = preliminary

Only the social welfare, labor and employment subsector is programmed










f = forecast

to have positive growth in real per capita terms in 2001. A significant share will be channelled to the Department of Social Work and Development’s

Comprehensive and Integrated Delivery of Social Services (CIDSS) program. to page 12



November - December 2000

of GNP) will balloon at around 3.5 percent of GNP.

President's budget... From page 11

Conclusion The President’s Budget for 2001 highlights difficult choices for policymakers in the face of clear tradeoffs between the key goals of economic policy. The consolidation of the national government’s fiscal position in 1990-1996 was impressive. From a fiscal deficit equal to 3.4 percent of GNP in 1990, the national government accomplished a major turnaround and posted a surplus of 0.9 percent of GNP in 1994. Perhaps, what is even more significant is the fact that the national government has replicated this achievement in the next three consecutive years from 1995 to 1997. However, after the Asian financial crisis in 1997, the national gov-ernment’s tax effort deteriorated and continued to slip despite the recovery in economic activity in 1999. Consequently, the fiscal deficit rose from 1.8 percent of GNP in 1998 to 3.5 percent of GNP in 1999. Given the flawed revenue forecasts, it is likely that the fiscal deficit targets for 2000 (1.8% of GNP) and 2001 (2.2%

On the one hand, our estimates of the fiscal impulse indicate that the proposed budget for 2001 is more contractionary than what is programmed in the BESF. On the other hand, our estimates also suggest that the fiscal deficit (both the BESF target and our own forecast) is not sustainable and may lead to an explosive situation where the large stock of government debt leads to an ever increasing debt service burden and consequently, to a vicious circle of high fiscal deficit—high debt burden— low growth. Thus, some tradeoff between growth and sustainability becomes apparent in the 2001 expenditure program. Consequently, one cannot overemphasize the need for improvements in revenue effort given the fact that it would be unwise to further reduce government expenditures (particularly MOOE and capital outlays which are at sub-optimal levels even now) in an effort to put the national government’s fiscal position on the path to sustainability.

On the expenditure program, while the social service sectors continue to receive the biggest share in aggregate national government spending, the proposed expenditure program for 2001 shifts resources in favor of the economic service sectors and general public services and away from the social service sectors. And although the incremental resources going to the economic services sectors are largely being allocated to productivity improvements in the agriculture sector, which is consistent with the government's growth and equity objectives, it is sad to note the corresponding decline in the real per capita national government expenditures on basic education and health care. This tends to undermine the government's poverty alleviation efforts since poor families, as earlier mentioned, are largely dependent on publicly providedbasic social services. Lastly, it is important to highlight additional risks to fiscal consolidation and sound public expenditure management due to the following: (1) the rising tax evasion rate especially in the individual income tax and value-added tax since 1995; (2) increasing pressures from various groups to reduce the tax base; and (3) the use of arrearages as a financing tool. DRN References

Table 6.

Real per capita national government expenditures on social services, 1997-2001 (In 1985 pesos) 1997





Total Social Services



























Health Social Welfare, Labor and Employment Housing and Community Development

Heller, Peter, R. Haas and A. Mansur. 1986. A Review of the Fiscal Impulse Measure. IMF Occasional Paper No. 44. Washington D.C., USA: International Monetary Fund. Manasan, R. 1998. Fiscal Adjustment in the Context of Growth and Equity, 19861996. PIDS Discussion Paper Series No. 98-11. Makati City, Philippines: Philippine Institute for Development Studies. Manasan, R. 2000. Improving Tax Administration: A New View from the Theory of Tax Evasion in a Corrupt Regime. PIDS Policy Notes Series No. 2000-11. Makati City, Philippines: Philippine Institute for Development Studies.


Oil exchange... From page 8

significant price discount, given our very small demand relative to the total market, and even with the volumes that major oil traders transact. Another charge made against the major oil companies is the alleged improper practice of transfer pricing. This refers to the overpricing of inputs (in this case, crude oil) by a mother company to its subsidiary which would inflate the mother company’s profits while reducing the subsidiary’s. However, actual practices vary here. While Petron has a supply agreement with ARAMCO (and not an exclusive one at that since Petron also buys from other sources), Shell, for example, reports that it sources most of its crude oil from non-Shell crude oil fields such as the National Iran Oil Company (NIOC), which is owned by the Iranian government. Thus, these facts would belie the accusation. If transfer pricing is really excessive, then it ought to be the case that


November - December 2000

you could import the final refined products from a major oil trading market like Singapore at significant savings. The DOE has estimated a cost “buildup” based on the Mean of Platt’s Singapore (MOPS) price for refined unleaded and diesel final products in August (Figure 2). This is the average price for those products prevailing in Singapore, a free and unfettered market, and so the prices should be competitive. Their computations in fact show that the completely built up price would have been higher than the then prevailing local prices: P17.23 vs. P16.85 per liter for unleaded and P14.09 vs. P13.03 per liter for diesel. In other words, an oil exchange would not have succeeded in reducing prices and may even have resulted, ironically, in higher prices. Moreover, economists recognize that transfer pricing is a valid management practice to optimize resource allocation among a firm’s various divisions when the transfer prices are set at their proper levels or at the opportunity costs of the transferred resources. Transfer prices allow the various divisions of a conglomerate to bal-

Figure 2. Unleaded Gasoline and Diesel Price Build Up, August 2000 MOPS-based (In pesos per liter)


4.35 SP TAX



10.82 FOB 10.58 FOB

17.23 Total Build-up

14.09 Total Build-up



16.85 Prevailing PP

13.03 Prevailing PP



Source: Department of Energy






All distributors would have to purchase their stocks from it (the oil exchange). This raises the question of whether the oil exchange will operate as a nonprofit or a profit-making enterprise. ance the flow of resources among themselves to optimize conglomerate wide profits. If a transfer price was set too high, then the “buying” subsidiary would get the signal that it is costlier than it actually is to engage in its operations and thus curtail its output. Moreover, it would have a more difficult time competing because of its “inflated” internal costs. In the context of this paper, an oil major could not maintain excessively “high” transfer prices in the long run because the other majors’ subsidiaries with the correct transfer price built in would be able to undercut its subsidiary in price. On the other hand, the “selling” division would be misled into thinking its operations were more profitable than it actually is and overproduce its output. Then when it tries to sell the excess outside the conglomerate, it discovers that it can’t sell any because the market price is lower than the transfer price. Overall profits of the conglomerate might suffer in the end. Thus, the conglomerate has an incentive to transfer price among its subsidiaries at the economically “proper” transfer prices, i.e., their true opportunity costs. For the most important objection to the oil exchange, meanwhile, we return to the fact that the proposal would institute a monopoly in the form of the oil exchange. All distributors would to page 14


Oil exchange... From page 13


November - December 2000

The first to respond to the rising price of oil have been the jeepney drivers/operators and the riding public who have taken to the

have to purchase their stocks from it. This raises the question of whether the oil exchange will operate as a nonprofit or a profit-making enterprise. If it operates for profit, then it will lead to a case of what economists call “double marginalization.” It will charge a margin for profit, and then on top of that, the distributors will also charge another margin for themselves. Thus, prices may even end up higher than without an oil exchange. Suppose it operates as a nonprofit [enterprise] and simply passes on whatever savings in purchase discounts it enjoys to the distributors.1 What guarantee is there that the distributors will pass on the savings to the consumers? In fact, if the distributors are a cartel or a monopoly themselves, they will tend to keep some of the savings for themselves. Thus, it would be an economically inefficient way of helping the consumer. This possibility is analyzed and dealt with more extensively in chapter 4 of U (2000).2 Then there are also other logistical problems. The Subic-Clark facilities will accommodate only about a fourth or 25 percent of the total Philippine market demand. Moreover, it has no LPG storage facilities. Thus, an oil exchange would still either have to build storage for the remainder (a very costly This seems to be what HB No. 12052 Sec. 8 contemplates: Sec. 8 Selling and Oil Pricing Mechanism – The OILEX shall sell, ex-plant and at cost, to all distributors and wholesalers all the refined petroleum products it will acquire. The cost, aside from the acquisition price, shall include recovery of expenses of the OILEX, etc. 2 Peter Lee U. “Deregulation and competition policy in the Philippine downstream petroleum industry.” PASCN Research Paper, Philippine APEC Study Center Network, August 2000. 1

streets to protest.

proposition) or lease it from the current private companies. Refining is also a continuous process. It cannot be shut down and started up easily like a light bulb. The oil exchange would create a highly risky business environment for refineries. If a refining company cannot be assured that it will win next month’s (or even the next few months’ bidding for that matter), what would it do with its output? The incentives would be stacked heavily in favor of simply trading and abandoning refining. This would not bode well for our security of supply. Monopolies likewise tend to be inefficient precisely because they have no competition. The government has not had a particularly good track record in operating monopolies. Witness the case of Nasutra. While the oil exchange will not engage in manufacturing, it may be inefficient in its administration of the exchange, e.g., purchasing, allocation and distribution of the refined products. Problems of graft and corruption also loom large in the bidding and allocation of the product as well as the bidding out of ancillary contractual functions like hauling, shipping and others. A government-run oil exchange would probably also be susceptible to political pressure to subsidize the prices of products to keep them artificially low. This is why the Oil Price Stabilization Fund (OPSF) ended up in a deficit when the industry was regulated and why the National Power Corporation is not profitable. Lastly, if the big three are in fact a monopolistic cartel and collude to overprice their products, they are able

BusinessWorld Top 1000, Vol. 14

to do so because they control most of the retail outlets. The oil exchange does nothing to address this. In fact, the oil exchange would simply deliver cheaper goods to this cartel to sell, assuming again that in fact it will be able to obtain the refined products at a substantial discount. Besides, if the big three really were colluding, could they not also collude and rig the submission of bids to the oil exchange? If this were the case, the solution is really enforcement of antitrust laws and empowering of the concerned government agencies with the resources to detect, prevent and prosecute, if need be, such anticompetitive behavior.

Summary We seem to have forgotten that the market has not always been regulated. For many years before martial law and the first oil crisis in the 1970s, the industry was a relatively free one with as much as four refiners and six marketing companies. The country apparently got along well with such a set-up. Ironically, the years of regulation and control since then have left us with the highly concentrated oligopolistic market structure for the industry, i.e., few players with large market shares. It is very difficult to deconstruct that and return to a more competitive market overnight. We need to be realistic and patient and give the oil deregulation law enough time to take effect. DRN


Interest... From page 16

The BSP may believe that higher domestic interest rates will offset the effect of the rise in US interest rates. The rationale is based on the interest parity condition. In equation form, this can be presented as: R* = R + (E/Ee – 1) where R* refers to the foreign interest rate; R, domestic interest rate; E, current exchange rate (peso/dollar); and Ee,expected exchange rate (the forward rate in covered interest parity). The equation (E/Ee – 1) is the expected rate of depreciation. Assuming R* and E e are given, an increase in R should lead to a decline in E for the equation to hold. However, if a risk premium is incorporated, then the analysis should be modified. The new equation (where “risk” indicates the risk premium, risk > 0) will look as follows: R* = R + (E/Ee – 1) – risk. Normally, the risk premium reflects considerations such as macroeco-

Editor's Notes There are, however, other equally important issues which President Estrada must face aside from the harsh allegations hurled against him and the impeachment trial. With nearly a hundred billion pesos in fiscal deficit by September 2000, the President's budget for 2001 will prove to be one big economic and administrative exercise for Estrada and his men. The nation's survival depends much on his—as well as his team's—ability to implement necessary measures.


nomic stability, prospects for economic recovery, and political uncertainty. The way it works out, the domestic interest rate must be higher than what is warranted in the standard interest parity condition in order to compensate for the risk premium. The fact that spreads on sovereign bonds are increasing for the Philippines indicates that the risk premium is significant and rising. When the BSP raised interest rates, it is not likely that they ignored the risk premium. What the BSP may have overlooked is that the risk premium is not invariant to a rise in domestic interest rates. Given that the ballooning budget deficit is the primary concern of investors, an increase in interest rates would only serve to exacerbate the situation. Higher interest rates increase the cost of servicing domestic debt. Furthermore, rising interest rates would surely dampen investment and consumer spending and this would have an adverse impact on an already fragile economic recovery. In algebraic terms, the rise in interest rates also led to an increase in the “risk” term, offsetting any effect on E. Moreover, if Ee also increased in response to the higher risk premium, E would therefore rise (the peso would depreciate immediately) as it did one PIDS Senior Research Fellow Dr. Rosario Manasan tackles these issues in the feature article by examining the President's 2001 budget. In conclusion, she suggests ways to achieve some degree of financial improvement through increased revenues on one side and sound fiscal management on the other. It would be an effort to turn the ailing economy and presidency around. This time, though, the people have been awakened from their stupor and have shown that they can be a major factor in bringing the country toward development. Here's hoping that everything turns out well for everyone in the coming year. More so for President Estrada. DRN

November - December 2000

day after the BSP announced the 400 bps increase in interest rates. Since the risk premium rises with the domestic interest rate but not as much, the only way to bring about a decline in E (peso appreciation) is to raise R by a significantly large amount. Hence, the proposal for reintroducing “Jobo” bills. But then, that would be tantamount to killing the patient in order to eliminate the symptoms of the disease. DRN

Vol. XVIII No. 6

November-December 2000

Editorial Board Dr. Mario B. Lamberte President Dr. Gilberto M. Llanto Vice-President Mr. Mario C. Feranil Director for Project Services and Development Ms. Jennifer P.T. Liguton Director for Research Information Ms. Andrea S. Agcaoili Director for Operations and Finance Atty. Roque A. Sorioso Legal Consultant

Staff Jennifer P.T. Liguton Editor-in-Chief Genna J. Estrabon Issue Editor Sheila V. Siar, Jane C. Alcantara Edwin S. Martin and Gizelle R. Gutierrez Contributing Editors Valentina V. Tolentino and Rossana P. Cleofas Exchange Delia S. Romero, Galicano A. Godes, Necita Z. Aquino and Federico D. Ulzame Circulation and Subscription Genna J. Estrabon Layout and Design



he peso is plunging. The ad ministration is suffering from a credibility crisis. Shades of 1983. To save the economy at that time, interest rates were raised to as high as 50 percent. Sure, inflation was brought down to virtually zero by 1986. In the meantime, though, the economy contracted by 15 percent in 1984-85. So why even consider issuing “Jobo” bills again? Let the man rest in peace. but even if this extreme measure is junked, the Bangko Sentral ng Pilipinas (BSP) must completely abandon any thoughts of raising interest rates further. It raised interest rates last 13 October. The result: the exchange rate is threatening to breach the P49 level. The BSP should stop and reflect. Otherwise, just as in the aftermath of the 1997 financial crisis, the economy would be hit with a double whammy: a high exchange rate and high interest rates. A depreciating currency is not necessarily a bad thing if the exchange rate is moving to its so-called equilibrium value. It should be recalled that one of the primary causes of overinvestment in the real estate sector—the trigger of the Asian crisis—was the overvaluation of currencies in the region. A high exchange rate (or weak currency) also benefits exporters and households relying on overseas contract workers' (OCW) remittances. Domestic manufacturers are also protected against cheap imports. The weaker currencies is one reason why the manufacturing sectors in the region—including the Philippines—have recovered strongly in the first half of 2000.

* This article appeared in the Letters to the Editor section of the Philippine Daily Inquirer, 24 October 2000. **Senior Research Fellow, Philippine Institute for Development Studies (PIDS). The usual disclaimer applies.


November - December 2000

The interest rate cure: Here we go again* by Josef Yap** However, if the peso becomes undervalued—as it has now likely become—then there is a danger of inflationary pressure. But this would be supply side inflation, which does not warrant an interest rate response. In such a situation, big importers must be encouraged to hedge foreign exchange risk to mitigate price increases. Meanwhile, the strength of the US dollar—or its state of overvaluation— should be self-correcting. Already there are indications that the Federal Reserve will intervene to stop the free fall of the Euro. This would then have ripple effects on other currencies. The Philippine peso is depreciating in tandem with the Indonesian rupiah and Thai baht. It is a regional phenomenon driven by net capital out-

flows and the strength of the US dollar. Foreign direct investment to these three countries has declined in the first half of this year. Portfolio capital has also fled the Philippines and Indonesia. High US interest rates are the main culprit. But deteriorating fiscal balances and political uncertainties have also contributed. However, a large chunk of capital outflows from the region is repayment of foreign debt. Penance for our profligacy in the past. There is nothing that high interest rates can do about this. But this time banks and corporations are prepared. The capital outflows have been anticipated and will not cause major disruptions as in 1997. to page 15

DEVELOPMENT RESEARCH NEWS is a bimonthly publication of the PHILIPPINE INSTITUTE FOR DEVELOPMENT STUDIES (PIDS). It highlights the findings and recommendations of PIDS research projects and important policy issues discussed during PIDS seminars. PIDS is a nonstock, nonprofit government research institution engaged in long-term, policy-oriented research. This publication is part of the Institute's program to disseminate information to promote the use of research findings. The views and opinions expressed here are those of the authors and do not necessarily reflect those of the Institute. Inquiries regarding any of the studies contained in this publication, or any of the PIDS papers, as well as suggestions or comments are welcome. Please address all correspondence and inquiries to: Research Information Staff Philippine Institute for Development Studies Room 304, NEDA sa Makati Building, 106 Amorsolo Street, Legaspi Village, 1229 Makati City, Philippines Telephone numbers 892-4059 and 893-5705 Telefax numbers (632) 893-9589 and 816-1091 E-mail address: Reentered as second class mail at the Makati Central Post Office on April 27, 1987. Annual subscription rates are: P200.00 for local subscribers; and US$20.00 for foreign subscribers. All rates are inclusive of mailing and handling costs. Prices may change without prior notice.

Exchange is no Change: Is Oil Deregulation a Failure