Growth and infrastructure imperatives

June 1, 2014
Introspective by Romeo L. Bernardo
(Business World) May 25, 2014

FORMER economic planning secretary and friend Ciel Habito and I have a lunch bet on the forecast GDP growth for this year. He is looking at a number north of 7%; we, just a shade over 6%. He wrote up a strong case for this in his column (“Seven Growth Drivers in 2014,” No Free Lunch, PDI, May 20).

 This is one time I would love to lose, but can’t bring myself (yet) to upgrade our number to 75 — despite the wave of positive feelings buzzing around, particularly at the recent World Economic Forum for East Asia (WEF-EA). However, reports of delays in public typhoon reconstruction, the daytime ban on trucks that is disrupting port operations, warnings of a potentially damaging El Niño weather disturbance by mid year that can extend to early 2015, still iffy goods export recovery, and the start of monetary policy tightening suggest that growth may be more modest, especially for the first quarter.
I do agree with Ciel and others that the Philippine economy has the potential to grow by more than 7% over the medium term. To get there, the resounding advice to government authorities during the WEF, is this: Infrastructure, infrastructure, infrastructure.Let me share some thoughts, as a former Finance undersecretary, and adviser/independent director in firms participating in PPP (public-private-partnership) projects who is called to provide occasional policy advise for multilateral agencies.
1. Our poor infra weighs heavily on the creation of more jobs and a better quality of life for our people. Academic studies point to the value of connectivity to bring people and goods to the market economy for growth and inclusiveness. International competitiveness surveys says we are the ugly belle in the ball because we have bad ports, airports, road networks, mass transport, logistic chains, etc.
2. The good news is that at this time — in contrast to where we were the past two decades — fiscal constraints and financing are no longer issues. Thanks to a combination of reforms taken over the years on the fiscal side — most recently sin tax reform — and a favorable macro environment — high global liquidity and a structural current account surplus fed by high remittances and BPO (business process outsourcing) earnings — we are now a net creditor country with improved debt ratios and an investment grade rating with access to long term financing matched to long gestation infra projects.

3. In the past, fiscal costs and risks loomed large in the minds of policy makers because of high profile projects with apparent large budget impact. Consider the oft cited stranded cost on power when demand did not eventuate because of the Asian Crisis. What is not fully appreciated is the much higher economic cost by far of under-provisioning. GDP flat-lined in 1991/92, representing opportunity costs equivalent to 4% of GDP annually for two years. Around P800 billion in today’s prices, equivalent to twice the government’s infra budget last year. A JICA study estimated the daily cost of poor transport conditions to be P2.4 billion a day in 2012; annualized its P850 billion or 8.5% of GDP!

4. The balance of risks has clearly moved away from fiscal risks to one of risks — no certainty! — of costly under-provision of infrastructure. And yet the pace in which projects are approved and implemented, including inaction on unsolicited projects both already signed and in the pipeline, the risk allocation between government and private sector being done in the structuring of projects (which earlier loaded risks like real estate taxes on the private sector) suggests continuing timidity that emanates from the top in some of the agencies.

5. While there has been progress in building a pipeline, most of these are still in study stages. Actual biddings done are few and far between, and seem in general not to have attracted enough bids primarily because of poor cost and risk allocation. I subscribe to the view that provided processes are transparent and competitive (including for Swiss challenges for unsolicited projects), government and the public sector get full value for the contingent risks government assumes, either by way of higher upfront concession fees it receives, or lower tariffs, depending on government’s bid parameter (which reflects what government is trying to optimize).

6. From where we are, there is high expectation that doing the first one for each of the sectors creates a model that makes it easier for succeeding ones, and for the program to ramp up quickly. The somewhat ambitious targets for 15 projects to be rolled out for the rest of the administration’s term seems to reflect this. Also the target of 5% of GDP in infra by 2016, from only half that presently. But time is running out.

7. There are a number of things government can do to help make sure this happens.

a.) Greater certainty in viability gap funding support. Right now, this is provided in the budget under the Strategic Support Fund on a per agency basis with a lapse of one or two years. In other countries, such support is provided via a continuing flexible and fungible dedicated fund open to all PPP projects meeting certain criteria.

b) Contingent liability fund. Likewise provided through an unprogrammed item in the budget and suffers from the problem of lapsing every year, and therefore does not protect investors over the contract life of the PPP. Perhaps this can evolve into a revolving fund where implementing agencies are forced to contribute a percent of their budget annually and upon which contingent liabilities called will be paid.

c) Firmer national government support in addressing bottlenecks that are thrown in the way of infra implementation — from right of ways, to hostage taking by local governments, and opposition by not-in-my-backyard activists. A good example here is the four year delayed 600 mw power project in Subic that should have now been contributing to addressing the consumer and economy costly thin power reserves.

d) Greater regulatory certainty. This is best highlighted in the case of the MWSS PPP, earlier hailed by the Finance Secretary as a most successful privatization. After a very high profile public pillory, this is now under international arbitration. MWSS is re-interpreting the treatment of corporate income taxes, 16 years after the signing of the contract. Similar regulatory unease is clouding EPIRA (the Electric Power Industry Reform Act of 2001) with the recent ruling by the ERC (Energy Regulatory Commission) backward adjusting spikes in rates of the WESM (Wholesale Electricity Spot Market) on grounds of market failure, something the generation companies are contesting. There are also efforts to issue new stricter guidelines under the Performance Based Rate Setting, including disallowing revaluation of assets and a heavier role of ERC in approving bilateral contract tariffs — effectively rate setting power over generation, the competitive segment of industry. This is on top of agitation to revamp the EPIRA law, which as business organizations uniformly declared, risks funding for much needed power projects if acted upon.

This situation of trying to keep rates low is present also in mass transport. For MRT 3, despite the clear case that has long existed for increase in tariffs, these have remained where they were since opening a decade and a half ago, at less than a third of full recovery tariff, and much lower even than what commercial buses are charging. In this case, it is the government, or, if you will, the larger tax-paying public including non-Manila residents, who are carrying these costs.

While the objective of government to keep tariffs low and affordable is fully understandable, we should be clear minded as well on the consequences that politicized, unstable policies have on PPP’s ability to contribute to addressing the infra misery. At the end of the day, from a public welfare standpoint, what is the most expensive, power, water, mass transport? Not having any. This is economically costly, having an impact on investments, jobs and quality growth. It should be made politically costly too.

(The author was Undersecretary of Finance in the Aquino 1 and Ramos administrations and is a Board Trustee of the Institute for Development and Econometric Analysis.)