Climbing Through Uncertainty: The Philippines
By: Ibarra Jonel Mari Gabertan
Inflation: A necessary evil?
Inflation is a common term both in and out of the academic realm of economics which, simply put, refers to the percentage change in prices of goods over a period of time. It is estimated using the weighted average of prices of various categories of consumer goods. A simple example would be how you would be hard pressed to find kopi-o at a hawker centre selling at $0.50 although it was commonly found at around those prices in the 1990s. There are a wide variety of scenarios that can contribute to the increase of prices. These include shortages of coffee beans due to weather, increase of stall rental price or demand by workers. Even the price of water has a bearing on the prices of a morning cuppa.
Figure 1. An artists’ impression of Inflation and the Economy (Source: Pinterest)
Even though any utility-maximising individual (myself included) would cringe over the idea of a morning kopi-o increasing to $2 over the course of the next few decades, inflation does have its benefits for the greater good when controlled. Depending on the context of the economy (developing, matured, etc.), a moderate rate that reflects a healthy balance of aggregate supply and demand will spur consumers to purchase a long-term good today rather than tomorrow. This increases the demand for that good (e.g. Housing) and in turn, signals producers to boost supply to meet demand. This cycle boosts economic growth, to our delight. As we know, the unpredictability of reality shies away the chances of a smooth sailing path towards these ideals from happening, to the dismay of governments.
The Philippines and Inflation
In June 2019, Philippines announced their inflation rate had increased for the first time in months, from 3.0% to 3.2% during the period of April to May 2019 . This was above the median estimate of 3% as predicted by economists which can be attributed to recent events such as the El Nino drought, rising oil prices and the African Swine Flu. All these events culminated in the increase of food prices to 3.2% in May from the 3.0% in April .
The central bank has also announced, two months prior, that it will reverse the contractionary monetary policy implemented in 2018, by decreasing their interest rate from 4.75% to 4.5% . Though the current inflation rate of 3.2% may not be too big a cause for concern at the moment, it is paramount for the nation to closely monitor volatile factors and stay ready in the face of those that they cannot control for. More importantly, it is definitely in the government’s interests not to allow its inflation rates to swell like they had the year prior.
Figure 2: An infographic reflecting the actual and expected inflation rates of 2018-2019
(Source: BusinessWorld Publishing)
2018 was a turbulent year for the Philippine economy, after President Rodrigo Roa Duterte signed off the Republic Act 10963 . The bill, named the Tax Reform for Acceleration and Inclusion (TRAIN), aimed to lower the income taxes of the poor and middle class whilst increasing tax rates for automobiles, fuel and petroleum, sugary beverages, tobacco products, cosmetic surgery and foreign currency deposits .
What followed was a chain reaction of events that led to the increase in food prices, particularly, triggering a rice shortage that greatly burdened the nation which eventually the country’s inflation rate as well. The country’s inflation rates hit its all-time high at 6.7% in the October 2018 from its last spike of 4.2% in 2011 . This begs the question if the acts should be passed in the first place.
How did the inflation rate rise so sharply in 2018?
We begin our answer with explaining the conditions prior to the tax reform. Philippines was already suffering from increasingly negative values in its balance of trade from the year 2015. This was caused by a steady increase of net exports, as well as, a slow growth in net imports within the same time frame. This in turn resulted in the decoupling of the Philippine Peso, which was labelled as the second weakest Asian currency in 2018 . This cycle, thus, led to the downward spiral of its balance of trade and ultimately facing all-time lows mid-2018 .
The next step to these turns of events is the TRAIN Tax Reform. We can essentially call it a manner of wealth redistribution; by increasing tax for the citizens of higher income and decreasing those of lower income. However, subsidizing the income tax of the prevalent lower-income citizens would require the government to generate more money to cover the money lost. As aforementioned, the tax rates for various consumer goods were increased, providing the necessary funding.
Figure 3: An infographic on the TRAIN Tax Reform (Source: medium.com)
The TRAIN Tax Reform also funds the Duterte Administration’s “Build Build Build” infrastructure plan, and is crucial towards the funding of the nationwide overhaul including the installation of airports, railways, bus rapid transits, roads, bridges and seaports. The purpose of these constructions are to create jobs, encourage Foreign Direct Investment (FDI), and create more efficient movement of people and goods . All in all, the Philippine Government wishes the reforms will create growth in the Philippine economy and reduce the rate of poverty to 13-15% in 2022, from its rate of 21.6% in 2015. Its last recorded poverty rate is 21.0% in 2018, suggesting improvement of the situation of poverty over the past few years .
Figure 4: An official infographic on the intended usage of tax revenue (Source: Philstar Global)
With all the prior conditions laid out, the consequences of the implementation of TRAIN resulted in heavier burdens on the middle- and lower-class citizens. With lower purchasing power of the peso and higher oil prices due to exogenous and endogenous factors, farmers saw the cost of crop production increase, resulting in the inflation of the prices of vegetables. Rice took the largest hit of price increase by 16% in September 2018 from the previous year . This then led to the increase of general food prices in the Philippine market, affecting both businesses and consumers alike. There is evidence that food price hikes were the largest contributor to the increase in the inflation rate in 2018 .
Figure 5: Philippines Food Inflation Rates from June 2018 – Present (Data Source: TradingEconomics)
Alleviating the Issue
The Central Bank responded to the uptick in inflation by applying contractionary monetary policies, gradually increasing interest rates from 3% to 4.75% over the course of May to November 2018 . Higher interest rates restrict the amount of money banks can loan, reducing the money flowing through the economy, which will theoretically slow down inflation. This came to pass in December, when inflation rates lowered to 5.2%, from its all time high of 5.8% in November . Following a stabilization in oil prices, and a better crop harvest in the later half of that year, food inflation had also decreased to 6.7% in November 2018 .
Key Points for the Future
What are some lessons to be learnt from 2018? For one, the tax reform had definitely contributed a fair amount of pressure on the inflation rate. As we had seen in the last quarter of that year, the government’s contractionary monetary policy stance combined with a decrease in global fuel prices, as well as, the stabilization of rice supply, all worked together to combat inflation.
- Rice Supply (Or lack thereof)
Although Philippines has shifted from an agrarian economy to one that focus more on services and production, it is still heavily reliant on the agriculture industry. The agricultural sector contributes 8.2% to its total Gross Domestic Product (GDP) . The nation is the world’s sixth largest rice consumer, consuming 13,000,000 metric tons of rice per year . More importantly, it has had a history of being resistant to importing rice to feed its demand, pursuing ideals of self-sufficiency and protection of local livelihoods by imposing a quota on imported rice .
As we can see from the case above, all these worked against the economy in 2018 with the shortage of rice the biggest culprit. Moving forward, President Duterte has approved a lift on these restrictions to increase supply and reduce prices. Effective from March 5 2019, unlimited imports of rice from ASEAN member states are subject to 35% tariff, whilst non-members are subjected to a 50% tariff. Whilst increasing the supply of rice by 1.2 million tonnes, the state predicts to gain US$511 million per year in revenue from the tariffs , posing benefits not only for the citizens in stable food prices, but income for the Philippine Government to spend on the country.
- Tight Oil Supply, Heat Waves, and Agriculture
As rationalised earlier, another main contributor to the inflation uptick of 2018 was the oil price hike which was largely attributed to the United States of America (USA)’s sanctions on Iran. Iran is the third-biggest producer of oil in the Organization of the Petroleum Exporting Countries (OPEC) .
This price of oil is also expected to continue rising through 2019, which makes it imperative for the government to focus on both the exploration on sources for oil, as well as, the development of alternative sources of fuel . Combined with the El Nino drought, all these poses a large threat to the agricultural industry. Due to this, Government agencies have been preparing financial aid for affected farmers, amassing a total of USD$7 million to assist their livelihood as well as to keep the prices of food low through the dry spell . This should keep the price of food from increasing too much over the period of the drought.
- Money Supply
As mentioned above, some part of blame and fear of the rising inflation rate lies within the Central Bank’s reversal of its interest rate from 4.75% to 4.5% in May 2019. As much as the decrease in interest rates would further spur economic growth, it could also result in the increase of inflation rates . In such a time of uncertainty, perhaps the safer option of keeping the rate higher than it originally was (for a few more months especially through the drought) would be a better option for the stability of the inflation rate, even though it risks the slowing of GDP.
The Philippine Government still has many other plans to reform other areas of its tax system. Most notably, its proposed successor to the TRAIN tax reform is the TRABAHO (work), which weeks to improve FDI by reducing corporate tax from 30% to 20% in order to incentivise small to medium businesses and investors alike . However, the bill was rejected in June 2019 due to a controversial clause that lifted the 5% preferential tax rate on gross income offered by investment promotion agencies, reverting back to the original 12% VAT rate. Furthermore, only 2,844 of the larger 915,000 firms registered in 2015 are tax incentivised, leading to disparity on the effectiveness of the reform .
The best lessons are those learned from experience, and certainly, the Philippines is no exception in doing its best to advance as a developing country. With a constant increase in GDP through the years of 5-7% from 2014-2019, the Philippine economy has been doing relatively well, aside from the setbacks brought up of the past few years, and is determined to eradicate extreme poverty by 2040.
Figure 6: The Philippine Government’s plans for the future (Source: TRAIN Tax Reform Magazine)