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January-February 1995

Easing Out


to Growth

Josef T. Yap and Celia M. Reyes

ISSN 0115-9097

Inside Capital Flows: When It Rains, It Pours 5 Greening Two Countries

NIC-hood Requires Brain Gain in Science and Technology 8 TheeCountryside: Trekking the Long Road to Boom Times

Despite a giant stride toward long-term growth, the Philippine macroeconomy still has to address the widening trade gap and rapid inflow of portfolio investment. Economic managers now have to deal with these issues effectively

without sacrificing the nascent economic growth.


igures confirm the recovery of the Philippine economy and the solid progress being made in several fronts. Improvements in infrastructure, particularly in power generation, curbed what would have been a substantial production backlog. Ongoing liberalization measures increased competitiveness of several sectors and encouraged more foreign investment. A stable macroeconomic environment led to a more conducive business climate. At present, the government focuses on how to enhance the competitiveness of the economy and provide for more equitable growth. With the advent of the ASEAN Free Trade Area (AFTA) and the General

Agreement on Tariffs and Trade (GATT), the pace of reform shall increase, making prospects in the latter part of the decade brighter.



FLASHBACK TO ‘94 Gross domestic product (GDP) grew by 4.3 percent in 1994, a dramatic improvement over the performances during the past three years (Table 1). This growth was accompanied, however, by an unusual combination: a relatively high inflation rate of nine percent, low interest rates, a larger-than-expected trade deficit, and a strong peso. This phenomenon can be attributed to the surge in capital inflows, wherein money F page 2

Editor's Notes


DRN’s year-opener presents a positive economic outlook for 1995-96 but with a “let’s hold off the rejoicing for now” tone. In their article, Drs. Josef T. Yap and

Celia M. Reyes, Research Fellows at PIDS, cite the government’s success in luring investments into the country. This in itself is good news. But since economic realities hardly exist in a vacuum, even such good news has its gray areas. Take the peso appreciation caused by the surge in capital in the last months. The government’s financial managers may have to do a balancing act here. Yap and Reyes tell us why. A related article goes more in-depth on the issue of peso appreciation. It presents

PIDS Vice-President Mario B. Lamberte’s pointers on some of the ways to counter public speculation about the direction of the peso rate vis-a-vis the dollar’s. This issue also includes an article about Finland’s success in overturning the fate of its forests; another on the need to produce graduates who answer the personnel requirements of local industries in the areas of science and technology; and a brief presentation of four recently-concluded PIDS studies on rural nonagricultural activities. l



If further channeled to the tradable sector, direct foreign investment can also boost export receipts and help narrow the trade deficit. Moreover, it is one transaction that can cover the country’s current account imbalance.

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supply increased peso appreciated.


January-February 1995



More money supply caused total domestic liquidity to surge by 24.9 percent for the first nine months of 1994, and lowered interest rates but pushed up prices during the first half of the year. Meanwhile, the continued inflow of foreign portfolio investment and capital reflows (also called “reverse capital flight”) prevented the peso from depreciating in the face of a widening trade gap. And since the prices of commodities in the country are always affected mainly by the cost of imports, the inflation rate turned around and began to decelerate as the peso’s strength continued in the last four months of 1994.

HERE COMES FOREIGN CAPITAL Any short-term macroeconomic performance, thus, depends a great deal on the behavior of foreign capital---a point underscored recently by Mexico’s experience. In the Philippines, one of the foremost concerns of its economic managers is how to cope with capital surges and still sustain its economic growth and development. Foreign investment is expected to propel economic growth but for such growth to be sustainable , it is direct foreign investment (in contrast to portfolio investment) that must be encouraged. Such type of investment can simultaneously increase output growth and encourage domestic savings, thus, narrowing the savingsinvestment gap.

Toward this end, there ought to be a sound macroeconomic management program. This means policies must be able to design a stable environment particularly in the presence of "speculative" capital inflows. Implicit in this is the need to attract the direct type of foreign investment into the country.

Monetary and fiscal policy must also be calibrated to prevent gyrations in macroeconomic variables, especially the exchange rate and inflation rate. If policymakers fail to finetune the macroeconomy, another balance of payments (BOP) crisis will likely ensue. Already, the trade deficit is widening considerably, and any massive net outflow of speculative investment may force policymakers to implement another stabilization program---a program that will concomitantly constrain economic recovery.

Table 1. Major Economic Indicators Philippines


Gross Domestic Product

1991 1992 1993

% change -0.4

Gross Domestic Investment % of GDP Gross Domestic Savings % of GDP Gross National Savings % of GDP

1994 1995







20.6 21.3 18.8 16.4 20.3 19.0

24.5 15.7 18.7

25.3 17.4 21.2

29.0 19.4 23.5

31.7 21.0 25.0

Resource Gap (I-S)

% of GDP








% change







Inflation Rate

% change in CPI







Exchange rate (average)


27.5 26.5





Merchandise Exports

$ billion % change

8.8 9.8 8.0 11.4

11.4 16.3

13.4 17.5

16.1 20.1

18.7 16.1

Merchandise Imports

$ billion % change

12.1 14.5 -1.3 20.5

17.6 21.4

21.6 20.5

26.3 24.1

30.7 16.7

Trade Balance

$ billion




-7.8 -10.2 -12.0

$ billion % of GDP

-1.0 -2.3

-1.0 -1.9

-3.3 -6.1

-3.0 -4.7

-4.2 -5.9

-3.9 -5.1

External Debt

$ billion

30.6 32.5





Debt Service Ratio

% of export 21.6 18.9





Current Account Balance

N.A. - not available. Forecasts made by Dr. Josef Yap.




Economic managers may be forced to apply stabilization measures unless foreign savings will be sufficient to cover the gap.

[P]olicies must be able to

design a stable environment, particularly in the presence of


"speculative" capital inflows.

Among the list of economic imperatives enumerated in last year's outlook paper by Yap ( see the DRN Mar-Apr 1994 issue), only the issue on social consensus has not been addressed completely. The present administration must factor in the importance of fora and other discourse groups on emerging issues (e.g., on GATT, value-added tax [VAT]), for it to build a development package that fits the needs and ideals of the population.

Related to the widening trade defi– cit is the continuous decline of gross inter– national reserves since July 1994. If the level of foreign exchange reserves falls below a particular threshold, it will en– courage speculations on the peso. C

1995-96: THE SWEET TASTE OF SUCCESS The recent economic recovery will continue well into 1995, with GDP growth projected at between five and 5.5 percent. Despite the economic upswing, however, there are still factors that can undermine the recovery process. These are the following: C

The burgeoning trade deficit was estimated at US $7.8 billion in 1994. The trade gap is expected to widen further in 1995, with the current account deficit equal to 5.9 percent of GDP. This is the third consecutive year that this figure will hover above four percent. There is some cause for concern here since the domestic savings rate has not been exhibiting a similar (i.e., upward) trend.



With the projected depreciation of the peso, inflation is expected to be on the uptrend anew and accelerate once actual output approximates its potential level. In this case, potential output remains relatively low because of the weak investment performance during the past decade, particularly from the public sector. Private investment, especially in durable equipment, has not yet fully responded to the expansion in economic activity. Usually, the manufacturing sector experiences the highest growth in times of recovery but in 1994, it fell below the entire industry sector’s growth. This implies that the high growth rates in the other subsectors of industry may not be sustained. Some analysts also cite the “Dutchdisease” effect of rapid foreign investment inflow on manu– facturing, i.e., the availability of foreign exchange causes relatively rapid growth in a nonmanu– facturing subsector which, together with the rise in foreign exchange reserves, removes the incentive to carry on structural reforms in the manufacturing subsector. As a matter of fact, growth in finance services (5.4%) was higher than that

January-February 1995


ositive developments have raised the likelihood of a sustained growth in the medium term. In this paper, the projections for 1995 and 1996 are based partly on the following assumptions: C

Structural reforms such as trade liberalization are expected to further increase the country’s trade competitiveness.


The government will pursue growth-oriented public spending and investment. Improved infrastructure will be one of its major goals. The power supply program has brought power outages under control.


Increased exports will propel economic growth. More com– petitive Philippine exports, coupled with stronger econo– mies of its trading partners, will bring in higher export revenues.


Increased foreign investment will close the gap between domestic savings and invest– ment financing. More capital can be attained now that there is more possible funding from East Asian economies.


Improved tax administration and new tax revenues will help break the country’s fiscal bind. Together with a prudent spending program, better tax generation will bring down the national government deficit.l


page 4



January-February 1995

Photo credit: DTI Annual Report 1992.

country. In this regard, electionrelated violence must be controlled.

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page 3

of manufacturing (5.1%) in 1994. C




The unemployment rate of 9.5 percent in 1994 was higher than the 9.3 percent rate in 1993, indicating that structural reforms have not corrected the capital bias of the economy. The Philippines will have to compete more with other Asian countries as an investment site. Thus, the expected inflow of more foreign investments may not materialize. Foreign portfolio, which constitutes much of the country’s foreign investment, is unpredictable and has relatively lesser impact on the real sector (e.g., Filipino's consumption and sav– ings) than do the direct type of investment. Direct investment, meanwhile, is increasing but remains relatively low.


he afore– mentioned competing forces are some of the reasons why the GDP growth rate will be 5.2 percent in 1995 but will decelerate to– ward either the end of 1995 or early 1996.

In 1995, the manufacturing subsector's

The deceperformance will pick up. Entry of more leration, however, investments in the semiconductor industry will be one of the reasons for the subsector’s will be moderated by expansion. two major factors: (a) sound macroeconomic management, the hallmark of the Ramos ad- undergoing a liberalization process for ministration, which will correct the the past years anyway. macroeconomic imbalances without plunging the economy into another Barring any major calamities, recession; and (b) continued economic agriculture will expand at a modest liberalization aimed at improving the two percent. Factors such as the business environment for both domestic uncertainty over the repercussions of and foreign investors. the approval of the GATT will prevent

In 1995, the primary source of economic growth will once more be the manufacturing subsector, which is projected to grow by seven percent. C Substantial gains in the peace and investments in the order situation during the present Increased will play a administration should be safe– semiconductor industry guarded so as not to erode key role in the subsector’s expansion. investors’ confidence in the Most of all, manufacturing will benefit from the increase in consumer spending that often follows a recovery in purchasing power (e.g., when salaries How did the sectors perform? are hiked). New developments 1991 1992 1993 1994 1995 1996 such as the ap– proval of the GATT shall have no Agriculture 1.4 0.4 2.1 2.4 2.0 2.3 drastic effects on manufacturing Industry -3.6 -0.5 1.6 6.1 6.8 4.6 since many of the industry subsec– Services 1.5 1.7 2.5 3.8 5.7 4.3 tors have been

the sector from growing at a faster rate. There are strong indications, however, that the tariffication process will have a net positive effect on the sector. By 1996, the sector shall experience a higher real growth rate. The services sector will benefit from the surge in the industry sector and grow by 5.7 percent in 1995. Value added in financial services shall register a high growth now that the entry of foreign banks has been liberalized and foreign portfolio investment continues to flow in. Economic growth in 1995 will most likely be consumer-led. The recovery will unleash consumer spending, which had been on hold since 1991. Growth in real total consumption is projected at 5.2 percent, one sign of full economic recovery.



Election-related spending this year will also fuel the increase in consumer expenditure.

January-February 1995

Capital Flows:

When It Rains, It Pours


uild-Operate-Transfer (BOT) projects will speed up next year, leading to a higher investment growth. Other modes of financial arrangements now allowed under amended B-O-T laws will encourage more private sector participation. Meanwhile, those investment projects began in 1994 as a response to the lower rate of real interest will be completed in 1995. Pork barrel projects that usually materialize in an election year will also add to investment spending. Growth of real total investment in 1995 is projected at 17 percent. Meanwhile, merchandise exports have shown remarkable growth in the past two years, and are expected to continue into 1995 and 1996. The jump in export growth can be attributed to the liberalization of regulations governing foreign exchange trans– actions. Exports should benefit from the economic reform process since the bulk of merchandise exports are heavily import-dependent.

STUBBORN TRADE DEFICITS However, projections presented in Table 1 indicate that the economy has not been fully restructured. Specifically, the wide trade deficit indicates that the import elasticity of production remains high. Delays in the full implementation of trade liberalization because of (a) BOP crises and (b) political pressure from threatened industries partly explain the wide gap. Although the change in the time frame of AFTA and a wide acceptance of GATT among different economies may hasten economic reforms

F page 12

A recent Far Eastern Economic Review article noted how capital surges can cause gyrations in the exchange rate. The Philippine experience in the last months is a case in point.


deally, the entry of capital into a country is a positive sign of a robust economy. True, surges in foreign capital have their benefits. There are, however, also destabilizing effects, as has been pointed out in local financial and academic circles. PIDS Vice-President Mario B. Lamberte, during a media forum on “The Impact of Foreign Exchange Movements on the Philippine Economy” at the Bangko Sentral ng Pilipinas (BSP) on November 23, added another point to the issue, especially with reference to the country’s case. According to Dr. Lamberte, no country can claim success with its liberalization program just because it has begun experiencing capital inflow. Only when it is able to minimize destabilizing effects such as sudden foreign exchange appreciation and inflation and maximize the positive effects of the inflows (e.g., more infrastructure, more new firms, more production output) on investment and growth can it claim unqualified success. Dr. Lamberte further explained part of the Philippine peso appreciation in the past months and underscored the importance of prudent financial management in

curbing, if not preventing, wild swings in the forex.

THE CONCERNS In the Philippines, foreign exchange inflows were mainly due to remittances from abroad, FCDU withdrawals and portfolio investments. In 1993 and 1994, portfolio investment soared remarkably as a percentage of the country’s gross national product (GNP) (Figure 1). Some businessmen, however, expressed concern over the short-term nature of the capital flowing into the country. For one, they say this type of capital is volatile since it can easily be “reversed.” That is, investors in the domestic stock market can withdraw their capital without difficulty, thus, causing stock price swings. Dr. Lamberte, however, corrected such concern by putting forth four points. One, long-term capital inflows can be as unpredictable as their shortterm counterpart. Two, recent financial market innovations blur the line between what are considered as “shortterm” and “long-term” capital. Three, most of the recent capital inflows go to F

page 14



During the 18th and 19th centuries,

January-February 1995

Finland extracted tar

from wool or coal and used it to preserve the surfaces of ships for the then budding shipbuilding industry. Because of excessive tar production, natural forests near the inhabited coastal areas of Finland were ravaged. Also, the shifting cultivation from the coastal areas to the inlands worsened the state of deforested areas. Today,

the situation


forests were

destroyed to

accom m odate a grow ing industry is a thing of the past for Finland.

Greening Two


Nevertheless, the private sector now owns 70 percent of the forest area---coincidentally also the most fertile area in the southern part of Finland. The government owns 20 percent of land, which is less fertile, while private companies own the remaining 10 percent. Back in the 1960s, the number of Finnish landowners who were not necessarily dependent on their land for their day-to-day existence increased because urbanization allowed them to find other sources of living in the cities. In fact, with the continued emigration to urban areas today, private lands previously reserved for agriculture and forestry will ultimately be used for recreational purposes instead. Among those families that do depend on land for subsistence, their income depends on the size of their lots. Table 1 shows the number of hectares an ordinary family of four in Finland has to own to meet the average standard of living. The table also shows the different land management prac– tices of the Finns. According to the estimates, a family in Southern and Central Finland has to own at least 25-30 hectares of land in order to live "respectably." This size is appropriate enough for milk farming. However, in Northern Finland, a family engaged in milk farming has to own 40 hectares to be able to live within the average standard of living.



rof. Anssi Niskanen of the University of Joensuu in Finland discussed during the Pulong Saliksikan sa PIDS on December 6, 1994 how Finland had overcome its severe deforestation and achieved a sustainable forestry sector.




THE FINNISH EXPERIENCE After the Second World War, according to Prof. Niskanen, the republic ceded large areas of its land to the Soviet Union as part of a peace agreement. Displaced Finns who resettled in the outskirts thus increased the number of family-owned farmlands but not the farm sizes owned per family.

The figures imply that the required number of hectares a family of four must own vary according to the different regions in that country and the type of land management practice. The least number of hectares in Southern Finland may not be enough to sustain the same practice in either Central or Northern Finland. However, milk farming requires the least number of hectares in the three regions, thus, it


is more efficient to practice it than grain production. The large farm sizes necessary to maintain an average way of life may have been one of the reasons why Finns work in other sectors, although they do not give up the land they already own.

PRESERVING THE FORESTS Development has turned Finnish workers away from agricultural activities, leaving a mere nine percent of the population to tend to arable land. Although the private sector owns 70 percent of the fertile forest lands, most (54%) are engaged in industrial and commercial activities. Because of this, forest areas owned by individuals were mostly left unravaged. It is no wonder that the forest sector has had sufficient time to nurture itself back to sustainability. Through the years, Finland has succeeded to maintain, and even increase, its wood growth. People’s awareness on the environment's perilous condition and fear of upsetting


January-February 1995

Table 1. Estimated Land Size a Finnish Family Must Own to Achieve the Average Standard of Living (In hectares) Land Management Practices

Southern Finland

1 Grain production 2 Grain production and forestry a) Grain production b) Forestry 3 Milk farming 4 Forestry 5 Reindeer husbandry (No forestry)

its biodiversity led to the establishment of conservation areas and restrictions in harvests. Thus, from a severe case of deforestation up to the early 1900s, Finland---where 50 percent of the net income earnings are traditionally forest products---is now in a sustainable basin. In fact, the forest growth since the middle of the 1980s had been so considerable that the rate of forest utilization has failed to catch up with the rate of its growth. In 1989, for instance, the annual forest cut was only 76 percent of the annual growth.

Central Finland

Northern Finland




20 70 25 150 -

20 110 30 250 -

350 40 350 1,000

CAN THE PHILIPPINES DO IT? Applying Finland’s forestry experience to the Philippine setting will not be an easy task. The latter will be facing a few, if not many, obstacles. Although Finland and the Philippines bear similarities in land management practices since they shared the same problems on deforestation 60 years ago, there are major differences in the development of their forestry sectors. F page 15

Putting a Value on the Benefits of Plantation Forestry


ow financially viable and environmentally friendly are the Philippines’ land management practices? In his two-year research project called “Socioeconomic and Environmental-Economic Profitability of Plantation Forestry in Thailand and the Philippines,” Prof. Anssi Niskanen aims to “calculate the financial, economical, socioeconomic and environmentaleconomic profitability” of the Philippines' land management practices. (The other country to be studied in this project is Thailand.)

For instance, one of the areas Prof. Niskanen will look into is the economic return in small-scale cultivation (e.g., upland cropping and privately managed plantations) vis-a-vis large-scale practices. The study will focus on five land management practices in the Philippines: upland cropping, privately-managed plantation using intercropping, grassland (grazing), community based contract reforestation and corporate contract reforestation.



overnments have since scrambled for the fast lane, only to find out that in all of the routes leading to economic progress, people’s involvement cannot be left out. In fact, a well-endowed people should be the core of all development plans, as experiences now show. Did the Philippines leave out on something very important? The answer is both “no” and “yes”.


January-February 1995

NIC-hood Requires

Brain Gain in Science & Technology

EDUCATED BUT POOR Surveys show that the Philippines has one of the highest literacy rates in Asia---higher than some of the countries that are now more economically advanced. Filipinos do put a premium on education. Even the small farmer or laborer who can barely eke out a living would send his children to school. Yet Filipinos barely move ahead. Is education not related to progress at all? “We may have to rationalize our education system so that it can respond to the real needs of the industries,” Science Secretary William Padolina said during a forum jointly sponsored by the Department of Science and Technology (DOST), The Asia Foundation, and PIDS. Truly, the country has been producing more of the professionals that industries do not necessarily employ as such. Take these examples: As an agriculture-based country, the nation has been pushing for courses related to agriculture. Yet, according to a survey, only 25 percent of agriculture graduates end up in jobs suited to their educational background. Neither have these graduates done much to improve the productivity of the land.

Natural resources ceased to be the sole measure







mercantilist era. What more does it take now to achieve economic progress?

The DOST cites the country's need to make its educational system respond to the requirements of local industries.



The same survey also shows that only one-third of engineering graduates end up as practicing engineers; the rest are employed as technicians or land in other jobs. Moreover, stories of teachers and other professionals who have turned into domestic helpers and entertainers are but a common Philippine reality.

NOT ENOUGH Another human resource issue is the sheer smallness in number of those who pursue higher learning, particularly in the different fields of science and technology. “How can we profess to become industrialized in the coming decade when we can still count with our fingers those Filipino experts (i.e., with doctoral degrees) in science and engineering? Other Asian countries, Malaysia and Indonesia included, have hundreds--even thousands---of their own experts.” This is a rousing assessment made by former DOST Secretary Ceferino Follosco in the same forum. “The notion that there are too many Filipinos studying abroad may be a thing of the past,” admitted Dr. Padolina. He recalled how disap– pointed he was when he found out that in an American university, Filipino

Photo credits: BOI Annual Reports (1988, 1982);



Report 1988


January-February 1995

students were lumped in the “others” category because “there were only a few Filipino enrolees”; in contrast, the numbers of Malaysian, Indonesian, Taiwanese, and other Asian students were more significant in the university’s population.

REASSESSING OUR PRIORITIES While the country boasts of having a huge labor force who speak English and are trainable, only a small percentage of these are highly skilled and have the capacity to steer the country toward NIC-hood. Lest Filipinos will be known forever to the rest of the world as “good” housemaids and entertainers, there is a need to arm the labor force with the right skills, knowledge and priorities. “In the past, the government has put little priority in developing our human resources. Official development assistance was poured into tangible projects [e.g., infrastructure] because these were easier to administer and monitor,” Dr. Ponciano S. Intal, Jr., President of PIDS, noted. “For instance, the Engineering and Science Education Project [ESEP] spearheaded by Dr. Follosco during his term at DOST did not have a smooth going during the review process of its proposal. [Although the popularity of human development was gaining ground among decisionmakers, there were still those who opted for infrastructure over human resources.] It is a good thing only a few of those who saw the wisdom in investing in people overturned the popular decision.” The ESEP finally made it despite the rough sailing.


page 15



ttaining a better future remains as slippery as a slick thief to many rural folks. In fact, despite a growth in Philippine agriculture, an improvement in rural welfare has yet to be seen. In the recently completed set of studies under the PIDS’s Dynamics of Rural Development (DRD) Project, researchers look at many of the countryside issues that inhibited many Filipinos from becoming better off.


than P1,000. January-February 1995

determination issues and methods, and rural issues that hindered, whether seemingly or realistically, an improvement in the rural folks’ welfare in the last three decades. According to the author, there were policies that tended to be biased against small-scale and medium-scale rural entrepreneurs. It did not help that, in spite of an existing land reform program, many individuals were still

able to hold onto wide tracks of land. Thus, incomes from crops mostly benefited the more affluent, land– owning farmers. It is the affluent farmers who also had more access to available subsidies and fertilizers. However, because they were likely to consume goods and services with high import content, such did not translate into the expected income and employment effects. While there are realities that did hinder an improvement in rural welfare, Dr. Balisacan also noted that the s t a t i s t i c a l methodology used in surveys sometimes fail to reflect the real growth that occur in the rural areas. This gives the impression that rural develop– ment programs are not really ef– fective in ac–

Dr. Arsenio M. Balisacan’s paper, “Ag– ricultural Growth and Rural In– comes:Rural Performance Indicators and Consumption Patterns,” delves partly into why the ordinary rural Filipino’s welfare has not improved. In his study, Dr. Balisacan iden– tified data and measurement issues, povertyPhoto credit: ACPC Annual Report 1988

Four DRD studies look at some of the realities in the countryside and provide reasons why many rural dwellers fail to be better off today.

The Countryside: Trekking the Long Road to Boom Times


celerating rural income growth. For instance, the author noted that the Family Income and Expenditure Files (FIES), one of the main sources of most rural poverty indices, reclassify many rural areas as “urban” once their population increases and/or their economy expands. Whatever break– through in say, poverty reduction, in the rural areas is registered as “urbanbased,” thus, underestimating the true growth of the rural sector.


} received

January-February 1995

[Rural] incomes from retail trade

and services are significant, particularly to the small and landless rural households.

FOLKS IN NONAGRICULTURAL JOBS Although “rural” seems to be uttered in the same breath as “agriculture,” rural dwellers do not wholly depend on agricultural activities for their daily needs (Table 1). Ms. Teresa Sanchez, a PIDS Research Associate, takes a look at rural nonagricultural activities---rural manufacturing activities, marketing of rural products, etc.--and how they contribute to labor in her paper entitled “Rural Labor and Rural Nonagricultural Activities in the Philippines.” Ms. Sanchez’s study is relevant now that the agriculture sector cannot seem to provide the needed employment to those in the countryside. Neither had the urbanbased industries provided employ– ment opportunities enough to absorb the growing rural workforce.

Incomes from nonagricultural activities complement what people in the countryside earn from agriculture. The study thus looks at how labor of rural households are affected by nonagricultural activities. In one of its findings, the study confirms the high proportion of rural labor engaged in nonagricultural activities. These activities are principally on retail trade and service. Incomes received from such kind of activities are significant, particularly to the small and landless rural households.

RNEs AND POLICIES Specifically, rural nonfarm enter– prises (RNEs), which are mainly manufacturing industries located outside Metro Manila, can be one answer to rural areas’ unemployment and

Table 1. Distribution of Income and Families in the Rural Sector by Main Source Main Source


Agriculture Non-agriculture Other Sources

47.8 35.5 15.1

1985 % Income 45.0 35.8 19.0


41.2 43.6 15.0

% Families Agriculture Non-agriculture Other sources Source: FIES, various years.


66.6 27.7 5.2

54.5 28.9 16.6

51.3 33.6 15.0

poverty woes. However, their positive contribution to the countryside is partly affected by government’s macroe– conomic policies. In another DRD study, how these macroeconomic policies on RNEs contributed to the improvement of their income and unemployment levels is explored. Ms. Aida Librero’s paper entitled “Effects of Macroeconomic Policies on Rural Nonfarm Enterprises” includes estimates that show the effects of macro policies on wages, exchange rate and merchandise exports. For instance, increases in wage rates was found to lower RNEs’ output through a decline in their employment and an increase in prices. Meanwhile, a rise in exchange rates initially increased domestic prices, which then lowered demand for goods and worsened unemployment. However, an increase in manufactured exports was found to raise output and employment levels of RNEs. Finally, a paper by Dr. Roberto F. Rañola likewise recognizes the biases of government policies and programs against rural areas as well as the resulting difference in development between rural and urban areas. In “Development of Rural Areas: Measurement Issues,” his recom– mendations to solve such a bias encompass a wide area: Increase in loans for agriculture vis-a-vis that for industry; better access to credit for small rural entrepreneurs; review of the import liberalization scheme; restudy of taxation policies and exchange rate; and more financial support for agricultural research and rural infrastructure. (Seven other DRD papers will be featured in forthcoming DRN issues---ed. ) l


Easing Out Roadblocks... From

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in the Philippines, a lag in the effects of trade and industry reforms and no immediate relief from import growth are seen for 1995. In fact, a larger trade deficit is expected to accompany the economic expansion in the next two years. The trade balance is projected to record a deficit of US $10.2 billion in 1995 and deteriorate further, albeit at a slower rate, to US $12 billion in 1996.


A ranking of

estimates shows that


January-February 1995

The exchange rate shall depreciate slightly (on average) as the government adopts policies, such as the removal of the foreign exchange cover for oil companies, to increase demand for foreign exchange. The widening trade gap shall, in due time, also exert its influence on currency movements. A ranking of the elasticities based on econometric estimates shows that the exchange rate is most responsive to the trade gap, interest rate differential, and medium-term to long-term capital flows, including foreign investment. Although economic reform mea– sures will admittedly be unable to prevent a slowdown in 1996, they will facilitate a “soft landing.” Real sector variables like production, consumption, and investment will experience declines in growth rates. Overall GDP growth in 1996 is projected at four percent.

the exchange rate is most responsive to the trade gap, interest rate differential, and medium-term to longterm capital flows, including foreign investment.


Fortunately, surpluses in trade in invisibles and transfer payments are predicted to keep pace with and even partially offset the trade deficit. The current account deficit is forecast at US $4.2 billion in 1995, or around 5.9 percent of GDP. Tighter monetary policy shall trim down the deficit slightly to US $3.9 billion in 1996.


price of tradables. Some research studies on the issue suggest that financial liberalization should be gradual and take place only after other reforms, such as trade liberalization, have been implemented. In the entry of foreign capital, externalities can also come into the picture. Take for example the case of capital borrowed from abroad. When one investor borrows, there are instances where foreign creditors may not distinguish between “official” and “private” domestic debtors and feel that debtor’s loans are implicitly covered by official guarantees only, even if the debtor is not a public institution. Thus, if private borrowers default on their debts, governments will have to bail them out or face discriminate increases in country risk premium or reduced credit. It is, however, difficult to reverse the policy of financial openness under the world market’s present conditions. Monetary, fiscal and exchange rate policies must therefore be able to maintain a stable economic environment---i.e., one not beset by

Because the foreign portfolio investment that surged into the country affected other aspects of the macroeconomy, economic mana– gers may have to Capital Flows into the Philippines take a second (In million US dollars) look at the struc– 1993 ture of their mac– 1st Sem 2nd Sem roeconomic policy. Inflows



1994 1st Sem 2nd Sem 2649


The expe– New Investments 176 158 692 43 riences of several Portfolio Investment 921 1336 1295 1429 countries show Bank Inter-Branch Operations 166 147 215 246 that financial Others 162 328 447 279 openness can initially bring in– to the domestic front a rush of capital, causing the real exchange rate to volatilities in the economy---in the appreciate above its long-run equi– event of capital surges. The private librium level. Dynamic problems then sector must also be advised against arise as the temporary increase in the overborrowing in the foreign capital stock of reserves puts a squeeze on the market. These strategies can prove to be formidable.




Foreign investment is

expected to propel economic growth but for such growth to be sustainable, it is direct foreign investment (in contrast to

borrow from foreign creditors to finance its deficit is great, since such action has the ad– vantage of being non-inflationary and does not crowd out private investment.

Although increased foreign b o r r o w i n g mitigates the need for a currency depreciation, the country cannot allow a repeat of its experience from the late 1970s to early 1980s, when foreign loans ballooned. Along this line, public financial managers’ current plan to float more government bonds in the international capital market should be reviewed more thoroughly.

portfolio investment) that must be encouraged.


An accommodative monetary policy that allows liquidity to grow along with capital inflows will lead to high inflation, especially if potential output is relatively low. This had been the Philippine experience during the first three quarters of 1994. Based also on the past, low interest rates need not lead to a currency depreciation. If the Bangko Sentral ng Pilipinas (BSP) decides to sterilize capital inflows, interest rates may shoot up, inducing capital inflows that may lead to further currency appreciation. An artificially strong currency, as men– tioned earlier, will hurt exports and exacerbate the trade deficit. An uncontrolled trade deficit, in turn, may provide the signal for foreign investors to withdraw their capital and spark capital flight similar to that in 1980-82. Fiscal policymakers can ease the burden of monetary policymakers if they maintain the fiscal deficit at “manageable” levels. Lower deficits mean the domestic capital market will have lesser need to borrow and the pressure on the interest rate will be reduced. To reduce such deficit, emphasis ought to be on revenue generation rather than foreign public borrowing. The temptation for the government to

January-February 1995


interest rates will experience wide swings. Gyrations in either the exchange rate or the interest rate will undermine past and present efforts to achieve macroeconomic stability. An alternative to the present system is a managed exchange rate policy similar to that being implemented by more prosperous East Asian economies. Aside from hindering vola– tilities in the exchange rate, the stable rate can also be used to facilitate orderly trade liberalization. In case of a perceived trend toward sudden appreciation, there are other measures that can boost the demand for foreign exchange (i.e., increase its value vis-a-vis the peso). In fact, the govern– ment has now implemented various measures along this line: phasing out forward cover on oil imports, increasing in exporters’ access to FCDU loans, liberalizing the ceiling on outward investment, and lowering tariff rates especially on capital equipment.

On the other hand, in case of a In the last few months, the inflow perceived tendency toward rapid of foreign exchange resources, in a depreciation, the BSP can moderate the floating exchange rate regime, caused fall in the peso’s value but the peso to continually should be careful not to appreciate and threatened induce a high interest rate the viability of exports. ‘ regime that can choke off Foreign Monetary authorities then investment. Investments, Net have to contend with the (In million US issue of what monetary dollars) It is also useful to aggregate to target. study how other countries deal with their own trade In a floating rate gap and capital surges. system, the monetary 1993 Needless to say, local authorities target either the policymakers cannot af– 1st Sem 241 level of international re– ford to commit the same 2nd Sem 371 serves or the exchange rate. mistakes. Given the in– If monetary targets are 1994 creasing trend toward used, then wide fluctuations globalization, where com– 1st Sem 840 in the amount of short-term petitiveness is a necessity 2nd Sem/p 370 capital will lead to wide gy– rather than a luxury, there rations in the exchange rate. is little room for error now. l On the other hand, if the BSP sterilizes these foreign exchange flows,

/p- preliminary figures until November 1994 only. Source:Bangko Sentral ng Pilipinas.



January-February 1995

rate appreciation and unsustainable current account balance that excessive Capital Flows... capital inflows bring. In his From page 5 counterargument, Dr. Lamberte explained that the experiences of several countries show that there are various measures Figure 1. Personal Income, Withdrawals of 343/547 Deposits to handle such and Net Portfolio Investments (As a % of GNP) problems (Table 1). Of course, there were varying results. Chile was able to manage its real effective ex– change rate. So did Indonesia and Ma– laysia. On the other hand, Korea and Mexico’s curren– cies experienced a sharp appreciation.

private borrowers who are subject to market discipline. Unlike in the 1970s and early 1980s, where the government was the recipient of loans, today’s borrowers are mostly from the private sector who are obliged to be judicious in their actions for their business’ sake. Four, there are now diverse institutional sources of funds. Thus, the possibility of spontaneous actions, such as mass withdrawal of investments, is lesser. Another concern pertains to the problems in macroeconomic manage– ment, such as inflation, real exchange

These results show that the various effects of policy responses to capital flows depended on policymakers’ priorities. For instance, most Latin American nations allowed real exchange rate appreciation, while most Asian countries did not.

STRIKING A BALANCE Dr. Lamberte noted that, in contrast to the case of other Asian nations, the Philippines went the way of the Latin American pattern because it allowed its real effective exchange rate to appreciate.

The Philippines’ public monetary managers, thus, should be clear as to their preferences. If it is the economy’s competitiveness that matters most to planners, then real appreciations of the domestic currency should be avoided. According to Dr. Lamberte, these monetary planners must also be discreet with regard to their actions so that the public will not misread such as “blips” in money supply. For instance, he cautioned the Bangko Sentral ng Pilipinas (BSP) from implementing a volatility band as a means to control the gyrations in the forex trading, noting that such would only reinforce large banks’ domination of the financial market. A volatility band involves suspension in foreign exchange trading for two hours if the current rate is 1.5 percent above or below the previous days’ closing rates. He noted that this two hour-recess may fuel more speculation. Fixing the exchange rate within the band can also lead to the loss of monetary control. Although monetary planners may have to keep their foreign exchange strategy to themselves to hinder speculations about the direction of the foreign exchange rate and interest rate, they should also strike a balance between such discretion, on one hand, and maintaining their transparency with regard monetary policies, on the other

hand, Dr. Lamberte further advised.SAT

Table 1. Major Economic Measures Used by Other Countries

Mexico Chile Colombia Korea Indonesia Malaysia

Moves Toward Fiscal Restraint a More Floating (Inclusive of paying Exch. Rate public foreign debt) (Widening of the band, limiting the use of swap facilities, pegging to a basket of currencies, etc.)

Sterilization thru Open Market Operations

Yes Yes

Yes Yes Yes Yes


Yes Yes Yes Yes Yes

Source: Vittorio and Hernandez (1993)


Sterilization thru Other Mechanisms (Increase in banks' reserves, increase in banks' capitalization rate, etc.)

Restriction on Capital Inflows (taxes to capital inflows, minimum reserve requirements on foreign loans, ceiling on foreign borrowing, etc.)

Liberalization of the Current Account (tariff reduction, etc.)

Yes Yes

Yes Yes Yes

Yes Yes Yes

Yes Yes

Capital Outflow Liberalization

Yes Yes



Greening... From page 7


From page 9

For one, according to Prof. Niskanen, the large Philippine population requires an even bigger reserve of natural resources. As of 1990, the population density is 535 persons per square mile, in contrast to Finland’s 38 persons per square mile. This is aggravated by a political sector that was, before the 1990s, not supportive of a long-term plan to



Although Finland

and the Philippines bear similarities in land management


...there are major differences in the development of their forestry sectors.


fight forest destruction and a land ownership structure that is quite constricting to tenant farmers as well as unsupportive of the private sector. What perhaps sets Finland apart from the Philippines is the former’s heavy dependence on the agricultural sector as a source of national income which, according to Niskanen, is the driving force behind the development of its forestry sector. He concluded that Finland’s formula “to the sustainability of its forestry sector cannot be the solution here in the Philippines.” The Philippines, thus, has to come up with its own formula. And learning from Finland's success story is but the first step. GEM

FROM BRAIN DRAIN TO BRAIN GAIN The ESEP, according to Dr. Estrella Alabastro, Executive Director of the Philippine Council for Industry and Energy Research and Development (PCIERD) and the Officer-in-Charge of the ESEP, is a project that supports technology development for industrial– ization by increasing the supply of welltrained science and technology man– power. The project’s components are engineering; basic sciences, including environmental science; science edu– cation; management of technology; and management of information system. The project is jointly financed by the government, the World Bank and the Overseas Economic Cooperation Fund.

January-February 1995

important is how the gain in knowledge and skills will be put to productive use. “What we have learned, let us put into practice right here in our land,” thus was President Ramos’s challenge in


let us put into practice right here in our land,' thus was President Ramos’s challenge.

The DOST’s mission does not end at producing a number of experts in science and technology. Equally


one of his speeches on the nation’s dream to become an NIC in the year 2000. OMS

New PIDS Publication

The engineering component aims to help develop masteral and doctorate programs in engineering in 19 flagship schools. It also helps upgrade these schools’ faculty and facilities and provides training for engineers in their counterpart companies. Meanwhile, the science component offers scholarship grants in masteral and doctorate levels in chemistry, physics, mathematics, bio– logy, molecular biology/biotechnology, earth sciences, statistics, computer science, pharmacology, and materials science in 10 schools. It also supports the upgrading of laboratory and library facilities, awarding of research fellowships, and exchange of professors and scientists, and the use and dissemination of research and develop– ment (R & D) outputs.

'What we have learned,

Breaking Away from the Fiscal Bind:

Reforming the Fiscal System* by Rosario G. Manasan


A publication under the "PIDS Review and Outlook of the Philippine Economy, 19931994" Project. 1994 130 pp

Inquire at : The Research Information Staff Philippine Institute for Development Studies



January-February 1995

Philippine Institute for Development Studies NEDA sa Makati Building 106 Amorsolo Street, Legaspi Village 1229 Makati, Metro Manila, Philippines


New PIDS Titles under the

Development Incentives Assessment (DIA) Project Industry Studies: v

Motorcycle and Parts byVirginia S. Pineda


Resin and Plastic by Cesar P. Banzon


Agricultural Machinery by Frances Myra C. Trabajo


Vol. XIII No. 1

January-February 1995

Editorial Board Dr. Ponciano S. Intal, Jr. President Dr. Mario B. Lamberte Vice-President

Packaging by Ma. Cristina S. Medilo


DEVELOPMENT RESEARCH NEWS is a bi-monthly publication of the

Ms. Jennifer P.T. Liguton Director for Research Information Mr. Mario C. Feranil Director for Research Services Ms. Andrea S. Agcaoili Director for Operations and Finance Atty. Roque A. Sorioso Legal Counsel

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 non-stock, non-profit government research institution engaged in long-term, policy-oriented research. The publication is part of the Institute's program to disseminate information and promote the use of research findings.

The views and opinions published 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 on the publication are welcome. Please address all related correspondence and inquiries to:

Appliance by Dennis D. Lapid Staff


Textile and Garments by Myrna S. Austria


Shipbuilding/Repair and Boatbuilding by Edwin Gil Q. Mendoza

A Review of the Remaining Import Restrictions by Loreli C. de Dios

For inquiries, please call The Research Information Staff Philippine Institute for Development Studies Tel Nos. 892-4059 or 893-5705.

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